Sunday, November 10, 2019
Spend, spend, spend, but beware the bond market
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

This is turning into an autumn of cancellations, not of trains because of leaves on the line, though no doubt there have been some of those, but of economic events. Last Wednesday was supposed to be Sajid Javid’s first budget but it was cancelled because of the election, the day after the chancellor insisted it would go ahead.

On Thursday, the Office for Budget Responsibility (OBR) intended to produce a “forecast restatement”, taking into account changes since its last assessment in March, notably the different treatment by official statisticians of student loans; which has added to borrowing. But this was cancelled too on the advice of the cabinet secretary, Sir Mark Sedwill, who said it would be in breach of the cabinet office’s election guidance.

Similar considerations led Sedwill to intervene in another cancelled event, the costing by Treasury officials of Labour’s spending plans, due to be published by Javid in a flourish, though as you may have seen elsewhere in the paper, they have found their way into the public domain.

When so much is being cancelled, what is a chap to do? Fortunately, there is plenty to fill the vacuum. The Institute for Fiscal Studies, which provided the OBR with its chairman, Robert Chote, stepped in on “the budget that never was” day the declare that the era of deficit reduction is at an end, and that the combination of statistical changes and the extra spending announced so far, will see the budget deficit – public sector net borrowing – rise above £50bn this year and next, from just over £40bn in 2018-19.

The increases will mean a budget deficit of more than 2% of gross domestic product, the old fiscal target, albeit one which was dropped by the chancellor in his speech on Tory spending priorities on Thursday.

What are voters to make of it? This election means that the end of austerity has come with a bang not a whimper. To adapt the old phrase, £100bn here, £100bn there, and soon you are talking about real money.

You will be pleased to hear that I am not going to go through every jot and tittle of the parties’ spending plans. The Green Party can, I think, claim an early victory in the spending-fit-to-bust stakes, with its plans for £1 trillion of extra spending over the next 10 years to deliver a greener economy. After taxes, that would add a gloriously precise £91bn a year to the budget deficit.

Both Labour, in the form of the shadow chancellor John McDonnell, and the Tories, through Javid, have ambitious plans for infrastructure spending. Under the Tories, it would be around £20bn a year higher than at present, averaging about £70bn a year in today’s prices over the next few years, according to the IFS. His aim is £100bn of extra infrastructure spending over five years.

McDonnell, promising “investment on a scale never before seen in this country” would, according to the IFS and Resolution Foundation, pledge to deliver £55bn a year of extra infrastructure spending, more than doubling it from current levels to roughly £100bn a year, approaching 5% of gross domestic product. There is a serious question about whether this amount can be spent wisely or, given capacity constraints, spent at all.

Both parties are, then, committed to a lot more infrastructure spending, borrowing to invest. Javid has constrained himself more than McDonnell, by adopting new fiscal rules that will prevent too much of a splurge and to try to constrain Boris Johnson, who does not come over a s fiscal conservative.

Those rules are for a balanced budget defined by current, or day-to-day, spending, a rule that already looks quite tight; the National Institute of Economic and Social Research suggests that it is already on course to be broken. There would also be a limit of 3% of GDP on infrastructure spending and a commitment to change tack if borrowing costs rise. McDonnell would target public sector net worth, an acknowledgement of the fact that infrastructure spending creates assets, and set a higher limit on any rise in borrowing costs. Whatever the rules are, recent experience would suggest that they are there to be broken.

What does it all mean? Is it, as the free market think tank the Institute of Economic Affairs says, that both parties have “abandoned fiscal restraint” in favour of more borrowing? Lord Macpherson, former permanent secretary to the Treasury, its senior civil servant, asks whether the fiscal proposals of the two main parties have ever been “so incontinent”.

Well, while Labour and Tories will always go out of their way to emphasise their differences, some things unite them. Both have seen the opportunity, in current very low borrowing costs, to push the boat out on infrastructure spending. The scale may vary but the logic is identical.

Without wanting to rain too much on their parade, there are two things to be concerned about, beyond the question of whether the extra spending can be sensibly delivered.

The first is that the main parties have embarked on relaxation with public spending, relative to GDP, at a much higher level than in past cycles. It was a notable achievement of the coalition and then the Tories from 2010 to bring down spending from a crisis peak of 46.6% of GDP to 40% last year 2018-19. Austerity may not have been popular but in this respect it worked.

If 40% is the low point, however, or close to it, it compares with a low point of 35.2% of GDP in 1999-2000 and 34.6% in 1988-89. Some of those comparisons were helped by strong growth in the economy but the point still stands. Leaving aside the impact of the crisis, if we ere to see the same rate of spending relaxation in coming years as during the Blair-Brown years of the 2000s, you could easily see spending rising to 50% of GDP.

The second cause for concern arises from the cross-party logic of borrowing to invest. Yes, it looks like a no-brainer to borrow cheaply, at current low rates, to invest. Javid, with direct experience of working in financial markets, knows this.
The logic, however, only goes so far. The circumstances that have given us ultra-low and in some cases negative interest rates on government bonds may not last. History would suggest that they will not. It is not good enough simply to commit to pulling back on borrowing if bond yields rise. By then it may be too late. The bond markets are powerful, as governments have often discovered.

Not for nothing did the US political adviser James Carville say in the 1990s: “I used to think that if there was reincarnation, I wanted to come back as the bond market.”

Debt is debt, and it has to be rolled over when the bonds issued to finance it mature. When the government borrows more to fund its extra spending, the fact that it can do so now on the basis of lower borrowing costs offers no guarantees for the future. The extra borrowing, the additional debt, may still end up as a very considerable burden on future generations. When politicians are splashing the cash, as they are now, remember that.