Monday, May 03, 2010

UK Financial Recovery and Election

Well the general election is this week, and its decision time about who to vote for....

As I have the right to vote I really strongly believe in using it. But I even more strongly cannot back any of the parties.

Rightly the economy is the biggest factor for the electorate at present. So where is that up to? My facebook friends will have seen my various tweets about this, that I ought to expand upon here.

I have my eyes and ears on one man for my economic advice. His name is David Blanchflower CBE who is a Professor of Economics. When I mention David below I mean Mr Blanchflower, not the tory leader. The reason I listen to him is he is the one voice that knew this recession was coming. He has a regular weekly column in New Statesman which I await each week with bated breath. He is also an economic adviser to the government, and sat on the Bank of England Monetary Policy Committee for a brief period, who he recently wrote have 'lost the plot'.

The recession and the UK economic recovery

So the UK is now out of the worst recession in decades by the skin of its teeth. A recession is commonly defined as a period of negative GDP growth for two consecutive quarters. GDP is the economic output of the country. Growth for the quarter just gone was provisionally 0.2%, and 0.4% the previous quarter. All the signs, such as consumer confidence, private business spending, money supply, the housing market and unemployment are all still unfavourable. For instance unemployment statistics show that the period each claimant is unemployed for is increasingly larger. Money supply to businesses and property buyers is still next to non-existent. The cheap 95% LTV (Ie 5% deposit) mortgage is consigned to the history books. A standard Buy-to-Let mortgage now requires a 40% deposit.

We are recovering from the recession, but this recovery is still at a clearly fragile stage. Any mistakes in economic policy today could end that recovery, and cause a double-dip recession. Avoiding a return to a recession should be of utmost priority. The only priority.

UK Government borrowing

Secondary to the above, but also important is the country's borrowing. UK borrowing is now approximately £167bn. This is a lot of money. An eye-watering amount. This will have to be brought under control and repaid. The Bank of England governor was recently quoted as saying in private that whoever has to make the cuts to repay it risk being out of power for a generation. Really tough cuts are coming and are unavoidable regardless who wins. Expect more stikes and large public unrest. The cuts needed have been summarised as equivalent to a 6p rise in income tax.

Any government has a tough balancing act between spending to prop up the economic growth and money supply, or making cuts to address the borrowing. As has been seen in Greece lately, unaffordable borrowing can be disastrous. If experts and investors feel a government cannot afford its level of borrowing, a country's official credit rating can be reduced. Greece was downgraded to junk status a couple of weeks ago.

So what if UK's rating is downgraded? We are currently enjoying the best possible credit rating. A downgrade would not be good. To consider the effects of a downgrade, my expert quotes yields on government bonds. UK bonds are currently trading about the same price as Italy. He notes that Italy's official credit rating is four 'notches' below ours. This he says is evidence that the bond markets have already priced a downgrading into their prices. So if a downgrade were to actually happen it would have a moderate effect on us. In summary, a return to recession should be a much larger concern than having our credit rating reduced by a notch or two.

The other effect of a country's finances being out of control is the sterling exchange rate. At the start of the storm about Greece a few months back, Sterling was still loosing ground against the Euro, which I saw as a very bad sign for Sterling. This again suggests that the level of our borrowing has already been priced into the markets, and a downgrade to our rating would not have a major effect. A weak sterling could even help stimulate demand for UK exports which become cheaper in real terms.

It is for these reasons David argues that securing growth is more important than repaying our debt at the present point in time.

Inflation and Deflation

The next issue is inflation. UK inflation has officially been 3% in February and 3.4% in March, well above the official target of 2%. However David believes these are a temporary blip due to energy prices, and the end to the 15% VAT holiday, and that inflation will drop back down to around zero very soon. The worst thing that could occur is know as deflation - negative inflation. This is bad because everyone will stop spending as officially goods will be cheaper in real terms if one delays spending. To try to avoid deflation UK interest rates are at a record low of 0.5%, and predictions say they will stay low for a while to come. Low interest rates help stimulate inflation, and vice-versa. Also a medium-term rise in inflation would not be a totally bad thing as it would make repaying the government borrowing easier, as the real cost of the debt would drop. As such, when inflation returns the government could allow it and increase their official target. I need to add that steady, and relatively low inflation is the ideal, and it was a real problem years back when it was 15%.

Again, securing growth will help raise inflation over the long term, and hopefully completely avoid deflation. Cuts too early will stifle demand, and consequently lower inflation.

So to summarise the above, the government borrowing is not an issue. Yes it will have to be paid for and reduced over the next five years. Yes we should have been saving money during the good times. But escaping the recession, getting the economy working properly again and protecting jobs should be the priority.

To summarise my summary, I support Labour's policy on handling the economic recovery. The tories plan of making cuts immediately with an emergency budget are very dangerous. Looking back through history, one will note that the great depression of the 1930's was caused by inappropriate government austerity measures during a fragile recovery. They caused a far worse recession.

Rise in National Insurance for businesses and employees, or rise in VAT

Labour are planning to raise £6bn by an increase in National Insurance. Tories have promised to scrap the increase. This money has to come from somewhere. Labour is already trying to raise billions by 'efficiency savings' and trying to find another £6bn is not realistic. This money will have to come from a rise in VAT instead. Or to put it another way if the money is not raised from businesses it will all be raised from you and I. On this subject I note many prominent economists (over 100) support the labour view, and many non-FTSE100 businesses (Ie no economic experts at all) support the tory policy.

Also at a time when government finances are this tight, I cannot see justification for such a huge increase in the inheritance tax threshold which Mr Cameron is proposing. Currently the limit is £325k and the tories want to triple this to £1,000k.

There can be absolutely no justification for such expensive tax cuts at the present time. Especially when arguing in the same breath for immediate and very serious spending cuts elsewhere based on the argument that it is a priority to pay back the borrowing today.

Other issues

Another issue for me is air travel. I'm not refering to the recent volcano in Iceland. Although this will possibly have an impact on our economy, I am refering to availability of flight slots. I am referring specifically to the extra runway at Heathrow, which Cameron opposes. We need more flights from more airports. International companies rely on them when choosing where to base their international offices, and when choosing where to host business meetings and conferences.

At present London is a very attractive proposal internationally, and we need to keep it that way! Please don't let all the environmentalists destroy this, on the basis of an unproven theory about climate change. No-one knows if it will happen, or what the effects of it would be with any certainty.

So three main reasons I can't vote tory:
  1. Handling of the present economic recovery.
  2. Scraping raise in National Insurance, and most likely having to raise VAT.
  3. Anti air travel policy.
However, there are a few strong reasons I could not vote Labour. I did say I agreed with their handling of the present economic recovery, and I also have to agree Gordon Brown did keep inflation under control as chancellor. But as any reader of some of my previous posts will know, I strongly dislike Gordon Brown. He has the worst record for raising back-door taxation. He can also be blamed for poorly preparing our finances for the recession. All world leaders seem to hate him, damaging the standing of our country with other world powers.

So for all that I strongly believe as I have the right to vote that I should use it, I even more strongly believe that I cannot vote for anybody.


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