Who would lend to a bankrupt Britain?

Wednesday, 9th December 2009

Alistair Darling’s budget forecasts assume that Britain can keep borrowing all it wants for the foreseeable future.We may not be so lucky, says Irwin Stelzer

As Messrs Sturzenegger and Zettelmeyer say: ‘All lending booms so far have ended in busts in which some of the beneficiaries of the preceding debt inflows defaulted or rescheduled their debts.’ This is especially true of countries that have substantial off-balance sheet liabilities. ‘These “skeletons”... have a habit of showing up in crisis times, when debtors are forced to make an inventory of their overall liabilities,’ they say. Think unfunded pension liabilities, obligations of quasi-public bodies, the implicit obligation to bail out entities the failure of which might cause systemic collapse. With such ‘skeletons’ Britain is richly endowed.

Now, enter what the markets are saying. The Wall Street Journal reports that two years ago it cost $5,000 per year to insure $10 million of British government debt against default for three years. It now costs $52,000 to buy such insurance — and $72,000 to cover that risk for five years. That is $30,000 more than it costs to insure BP’s debt, and $50,000 more than to insure Germany’s. So the markets think it is more likely that UK plc will default than BP plc. Or McDonald’s. Or Gap.

It is, of course, a long way from here to a British default. Much will depend on whether spending can be contained. The outlook is not good. Even George Osborne’s plan to attack spending, not with an axe but with a paring knife, is under attack from his colleague, Ken Clarke, who is warning him not to get ‘too adventurous’ in attacking spending.

Labour’s plans need not be considered: either they will lose the next election, in which case their plans are irrelevant, or they will win, in which case Gordon Brown is unlikely to find a spending cut that will not interfere with economic recovery or offend some constituency — putting default back in the running as a possibility.