Sunday, November 16, 2003
Can we relax about debt?
Posted by David Smith at 11:49 AM
Category: David Smith's other articles

“EVERYONE needs to think carefully about the amount of debt they can afford.” So said Mervyn King last week in the nearest the Bank of England governor came to responding to calls for him to adopt a suitably stern attitude to irresponsible borrowing.

The truth is, though, that however much he might like to raise his eyebrows aggressively about debt, King’s heart wasn’t in it. The Bank’s view is that, while a small minority may be going over the top in borrowing, the vast majority is not — despite some unnecessarily alarmist media reporting.

So, while it is almost incumbent on central banks to worry about such things, the trouble is that pretty well every measure the Bank looks at tells it there is nothing much to worry about. A decade ago 50% of new mortgages were on a loan-to-value (the loan in relation to the house price) of more than 90%. Now the figure is 20%.

In the early 1990s the number of mortgages in arrears topped 200,000. Now the figure is 30,000. Housing repossessions reached 60,000 a year, 12 times the current annual number of about 5,000.

Most of all, a strong rise in household debt over the past decade has not resulted in an increase in the debt-servicing burden. This burden — the cost of monthly mortgage payments in relation to income — has been steady over the past decade and well below the crisis levels of the late 1980s and early 1990s.

King echoed a point made here last week. Even if interest rates were to rise to 5%, they would only be returning to levels that until a couple of years ago were regarded as very low. The broad conclusion has to be that, while the Bank’s monetary policy committee will continue to take each decision as it comes, fears of precipitating a debt implosion won’t prevent it from raising rates further, although probably not as early as next month.

Surely there must be something to worry about in the rise in debt? Perhaps the Bank is obliged to look at it through rose-coloured spectacles. After all, the debt increase has happened on its watch. If it all goes wrong, it will have some explaining to do.

Official figures suggest that personal bankruptcies are increasing sharply, though the number of people affected is still small. That, however, could reflect a range of things. The government, after all, has taken steps to “remove the stigma” of bankruptcy, which could have encouraged some people to wipe the slate clean rather than working off their debts.

There is also the question, raised in the Bank’s new inflation report, about whether we are living in something of a fool’s paradise when it comes to wealth. Rising house prices make us all feel wealthier, but one man’s gain is another’s mortgage burden.

“It is not clear that rises in house prices should cause households to be wealthier in the aggregate,” the Bank says. Debt, on the other hand, hangs around and has to be repaid. For the Bank, however, that is mainly a matter of individual choice, not economic policy.

If the Bank is not unduly worried about household debt, the Treasury seems similarly unconcerned about the debt it is running up on behalf of the government.

I have seen a few fiscal crises in my time. They are usually characterised by visible signs of discomfort from the chancellor, his advisers and officials, as the Treasury gets that sinking feeling, knowing that the public finances have run out of control and only painful measures will get them out of jail.

This time, though, everybody from Gordon Brown downwards seems remarkably relaxed. Not only do the chancellor’s fiscal rules have to be met, they will be met.

The Treasury’s confidence is based on debt. One of Brown’s two fiscal rules, the so-called sustainable investment rule, requires that the national debt (public sector net debt) be kept below 40% of gross domestic product. The Treasury’s own projections suggest that while debt is rising, it will still be less than 34% of GDP by 2007-8. To give an idea of the orders of magnitude involved, debt would need to be about 90 billion higher than projected to break the rule.

Low debt is regarded by the Treasury as the jewel in Britain’s fiscal crown. It enables the chancellor to lecture other EU finance ministers on their public finances. It also means, according to the Treasury, that current concerns over the public finances are misplaced.

What about the other fiscal rule, the so-called golden rule? This requires that, over the course of the economic cycle, the government only borrows to invest, and not for current spending, such as public- sector wages and salaries.

Many independent economists have warned that taxes will need to rise by about 10 billion to meet the golden rule, which since 1997 has usually been regarded by outsiders as the more important of the two rules.

Suddenly, though, the golden rule has become something of a poor relation in the Treasury, a slightly embarrassing second cousin to the really important one, the sustainable investment rule. The golden rule, it is pointed out, can lead to distortions, unnecessarily favouring public investment over current spending where it is not justified for other reasons. It is also hard to measure, requiring a more definite view than is possible about when the economic cycle begins and ends.

So the word is that taxes are not going to rise imminently to meet the golden rule, as long as debt remains so low. The Treasury will pursue a tough spending round, to ensure that government outlays rise at a slower pace from 2005-6 and debt remains under control. It may even be that this turns out to be enough. Goldman Sachs has stuck its neck out and predicted that the chancellor will meet both his fiscal rules, and that no net tax increases will be needed.

The politics of this, of course, are plain. Labour has a general election to fight, probably in 18 months. The idea that the chancellor is going to zap middle-class voters with a tax rise ahead of that is barely credible.

Afterwards it could be another story. If Goldman Sachs is wrong, we may well find that the government persists with its pattern of announcing a big tax increase early in the parliament. The golden rule would be brought back in from the cold. And the Treasury would not have been quite so relaxed about debt after all.

PS: The Tories have had more shadow chancellors than Leeds United has had football managers. Oliver Letwin is the sixth to face Gordon Brown since May 1997 and, while it is important not to prejudge him, his approach may be far too gentlemanly for a chancellor who takes no prisoners. The others, by the way, were Kenneth Clarke (in a caretaker capacity), Peter Lilley, Francis Maude, Michael Portillo and Michael Howard.

Brown has almost certainly broken a record for most shadows, (you could call it a Cliff Richard record), just as in September he quietly passed Nigel Lawson’s milestone as the longest-serving post-war chancellor. Lawson did six years and four months. Only David Lloyd George lasted longer, doing seven years and a month between 1908 and 1915.

Assuming Brown gets through Lloyd George’s milestone, the possibilities become interesting. If Tony Blair were to step aside for him midway through the next parliament, both would have clocked up 10 years in office. As far as chancellors go, that would be the kind of record unlikely ever to be broken.

And by that time, we would doubtless have seen a few more shadow chancellors.

From The Sunday Times, November 16 2003


Hello there,

I am writing to comment on the article how the UK views President Bush and his policies.
As an American, we view the President's policies in a much better light than Europeans because he reminds us - all the time - that we are in a War against terrorism. And no matter how much one might mistrust his policies and his intellect, one is forced as a matter of patriotism, to choose War and defend ourselves. And who can argue against that point of view?
Thank you,

Posted by: Alex Briones at November 23, 2003 06:59 PM