A few months ago, Alistair Darling was asked how long he thought his government could continue to borrow £600 million a day. Might creditors one day refuse? The Chancellor gave an oblique reply. ‘When you walk over ice, you never know it is too thin — until you fall through.’ He said no more, but his message came across. If the bottom falls out of the British economy, it will do so instantly and dramatically. There will be no warning.
For some time now, Gordon Brown’s government has been walking on the thinnest of ice. But it has been helped, ironically, by the widespread expectation of its electoral annihilation. The money markets — which decide daily whether to extend the financial lifeline upon which the Prime Minister now depends — had priced in a clear Tory victory. Pension funds and foreign investors were banking on David Cameron winning, and being obliged to restore fiscal sanity.
Over the last fortnight, this expectation has been shattered. The slump in the Tory lead to just two percentage points in a YouGov poll last weekend was the tipping point: sterling nosedived the very next day. But despite what Tory spin doctors say, the fear is not about a Labour victory. Even Mr Brown would be forced to repair the damage he has wreaked, if he had five more years in power. The nightmare haunting the markets is of a hung parliament, the possibility of a second (or third) election, and a country in fiscal meltdown with no one properly in charge.
It has been so long since Britain has seen a hung parliament that it has faded from political memory. Politicians and the media think in binary terms, of victory or defeat — yet the Westminster system is capable of delivering neither. Citigroup has published a graph (printed opposite) alongside its economic research: most polls coming out now suggest that the Tories would form a minority government. In the British system, this would not mean a Prime Minister struggling on as best he can. It would mean chaos. And as in 1974, chaos eventually leading to a dissolution of parliament.
The myth of a workable coalition government, too, should not be taken seriously. History shows that Westminster’s adversarial system does not accommodate it. Of the four hung parliaments over the last 100 years, only one — Ramsay MacDonald’s in 1929 — lasted more than a year. More worryingly, of the three elections in which a government won a parliamentary majority of less than ten seats, only one (James Callaghan’s) lasted more than two years. Unless Mr Cameron wins significantly — which today’s polls suggest he will not — he will immediately be preparing for a new election. And so will everyone else.
The markets are already growing jittery at the prospect. Gilt yields have risen sharply: the UK government now has to pay close to 1 per cent more in interest than the German government for a ten-year loan. Such rises will ricochet down the economy, passed on to companies and homeowners. Not only do we need to pay more than the Americans and French — but our debt is now deemed to be a riskier prospect than even Italy’s, an astonishing about-turn and humiliation. British government IOU notes have long been costlier to insure than those issued by McDonald’s.
Britain technically still has an AAA debt rating. But this gives a false sense of security. The agencies that decide such ratings have been largely discredited, having given a similar rating to many disastrous bundles of sub-prime mortgages during the bubble days. Government debt is increasingly being seen as the new sub-prime; and the British government relies on such debt to find £1 in every £4 it spends, including on the wages of the 7.2 million public sector workers.
And that is not all. Saxo Bank believes that we have witnessed ‘what can justifiably be called the beginnings of sterling’s collapse’ — and one caused by the prospect of a political power vacuum. It sees the pound tumbling to $1.20 by the summer — it was $2 two years ago and fell to $1.50 this week. Even if one is not that pessimistic, it is clear that the only way forward for sterling — or the GB Peso, as its detractors call it — is down.
While it is hard, almost impossible, to predict how close Britain is to the edge of the financial vortex, we know — by looking at the countries that have already slid in — what happens when things go too far. Expectations of collapse drive reality. A serious sterling slide would trigger widespread panic and further spook the debt markets. Why would foreigners continue to buy UK gilts if the value of sterling keeps on falling? They would be watching the value of their investment plunge. So they will demand even higher interest rates to compensate them for the risk — which, in turn, will frighten the markets, and burden British taxpayers even more.
Meanwhile, foreigners with any kind of investment in the UK will be facing massive losses; the Russians, arabs and Europeans who are still propping up the London housing market might finally stop buying. The strange, irrational mini-bubble in the housing market which has seen house prices recover in defiance of gravity, might pop. Combine that with upwards pressure on interest rates on mortgage and business loans (everyone’s debt is based on the price the UK government pays for its debt) and we will be facing a hit to consumer spending as well as business investment. Add in growing inflationary fears to the mix and we are facing even weaker economic growth and increased unemployment in the months ahead.
And how indebted is Britain already? McKinsey & Co, the management consultants, estimate that total debt in Britain — household, corporate and government — is now 466 per cent of GDP. Similar to Japan’s 471 per cent, and much higher than America’s 300 per cent and Germany’s 285 per cent. The idea of Britain as a low-debt country is an anachronism. Yet it is one which is still repeated in many parts of the media. Mr Brown publishes the metrics which best conceal the debt. And we all know how that approach worked for the US sub-prime housing market.
Markets flip quickly into panic. There are several reasons why Britain can expect to avoid an outright default on its debt. In extremis, we could always print more pounds or engage in renewed quantitative easing. Thanks to the decision to stay out of the euro (one for which Mr Brown deserves credit), we still control our own currency and central bank, unlike Greece and Italy. The slump in sterling will boost our exports. If the drachma were still around, it would have hit the floor — and the world would be making its way to Greece this summer for South African-style prices, thereby helping to reflate its economy.
The most likely way out of the vortex would be an IMF bailout; it would be the third in 45 years. The first, which is regularly forgotten, took place in 1968-1969. Things started off with a sterling crisis, and led to requests for help from the US and the G10 as well as (repeatedly) from the IMF itself. By 1976, Britain was in crisis again; a US standby loan had to be supplemented with help from the IMF, which came with stringent conditions attached, in exactly the same way that Greece today is being ordered by the EU to make sharp cutbacks to spending in return for a bailout.
So when Lord Mandelson speaks of ‘destigmatising going to the IMF’, it is fairly clear what he has in mind. There are senior Tories who say their ideal scenario is for Labour to take Britain to the IMF, then for the UK government to be forced to accept a radical cuts programme which a new Conservative government could blame on someone else. The feeling in parliament is the same as in the markets: that without heavy external encouragement, no government would have the will to make the necessary cuts. The impetus is simply not there on either side.
The explanation for this lack of impetus is simple: a cuts agenda is politically tricky. When Britain has coped with fiscal crises in the past, they have always triggered intense political struggles and often destroyed governments. In the 1920s, pressure from Lord Rothermere’s anti-waste league convinced Lloyd George to appoint Sir Eric Geddes to review spending. His committee of businessmen helped slash total expenditure by 6 per cent in real terms — with cuts to most departments.
In 1976 it fell to the Labour chancellor, Denis Healey, to propose cuts of £1 billion (the IMF demanded five times this amount when they came in a few weeks later). He had to face down opposition from the Labour left — led by Tony Benn — who argued that to cut at that time would deepen the recession. Their refrain, dismissed by Callaghan then as extreme and economically illiterate, is now Gordon Brown’s official position. This is, of course, why Brown’s deficit is twice as big.
And the Tories? The secret is that there is no plan, not beyond the £7 billion of cuts they intend to make to our structural deficit of about £100 billion. Both Mr Cameron and Mr Osborne believe that the civil service will draw up a cuts plan — and that if they draw up one of their own, it could leak during the election. In their more optimistic moments, senior Tories have been heard to say that the civil service can cut 20 per cent without affecting front-line services.
When Britain has fallen into the fiscal abyss before, it usually drags itself out fairly quickly. When Callaghan returned with his orders from the IMF, his cuts were accepted without discussion in his Cabinet. But the process is destructive: of wealth, of national self-confidence, and of Britain’s reputation in the world. It may well be that a Conservative government is elected with a strong majority, and can steady the nation. But failing that, all the conditions are in place for Britain to suffer a Greek-style slump. And our gloomiest visions may yet become reality.
Allister Heath is editor of City AM and an associate editor of The Spectator.