Sunday, August 28, 2022
Debt can only explode when one crisis follows another
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. Not to be reproduced without permission

In the summer of 2021, just over a year ago, I had a long chat with a senior Treasury official – OK it was the former chancellor – who was worried about what the future might bring. At the time, there was a much-quoted estimate from the Office for Budget Responsibility (OBR) doing, which was that a sustained increase of a percentage point in inflation and interest rates would add £20 billion to the government’s annual debt interest bill.

Back then, with Bank Rate stuck at 0.1 per cent, as it had been since March 2020, gilt (UK government bond) yields less than 1 per cent and inflation in July 2021 bang on target at 2 per cent, there did not seem to be too much to worry about.

But Rishi Sunak was concerned, and I owe him, with hindsight, an apology. A few months earlier, at the end of November 2020, in unveiling a one-year spending review, he used the phrase: “Our economic emergency has only just begun.” I and others criticised him for laying it on a bit thick. The economy had bounced back sharply from its slump during the first lockdown in the spring of 2020 and appeared to be coping well with the second lockdown then under way. The prospect was of a strong post-pandemic recovery in 2021.

However, while he could not have predicted the Russian invasion of Ukraine and its consequences, he was right about the emergency. The interlude between end of pandemic restrictions and this cost-of-living and cost-of-doing-business crisis was brief. From the end of the third lockdown in early 2021 to the Russian invasion of Ukraine in February 2022 was less than 12 months. “Normality” was brief; one crisis quickly morphed into another.

It is hard to overstate the seriousness of the current crisis, following Friday’s announcement of the energy price cap for the final quarter of the year. Normally, though it may not always feel like it, household incomes are protected during difficult times for the economy. Real household incomes per head held up well during the financial crisis more than a decade ago, only falling back, but not by much, in the early austerity years after 2010 and after the 2016 referendum.

They also held up well during the recession of the early 1990s and, thanks to large amounts of government support, during the pandemic. That is why the fall in real incomes in prospect now is the biggest since records began at the start of 1955. This is indeed serious.

So it is for business. When the British Chambers of Commerce and others call for Covid-style support for firms during this energy crisis, as this newspaper did last weekend, they know what they are talking about. The increase in energy costs faced by many businesses, notably energy-intensive firms and small and medium-sized businesses (SMEs) represents the difference between survival and closure. Lockdowns are a thing of the past but many, particularly in hospitality and retail, are operating on a partial lockdown basis because of staff shortages and rising energy costs.

Crises, and recessions, are not like London buses. They are not supposed to come so quickly after one another. You will recall that after the global financial crisis, a new one was predicted virtually every year.

As it was, the economy had time to adjust after that crisis, as did the public finances. The budget deficit, which peaked at 10.1 per cent of gross domestic product (GDP) in 2009-10, was down to 2 per cent by 2018-19, the eve of the pandemic.

After the recession of the early 1990s, there was even longer to repair the public finances, though in the event only a few years were needed. A budget deficit of 6.6 per cent of GDP had been converted to a surplus by the late 1990s, the early years of the Blair-Brown government.

This time, after the massive blow of the pandemic, when public sector net borrowing, the deficit, reached a massive £309 billion in 2020-21, 14.4 per cent of GDP, the repair job has hardly begun before another crisis, which will require huge fiscal support, has hit. Even in 2021-22, a recovery year, the deficit was £144 billion, or 6.1 per cent of GDP, close to its peak after the early 1990s’ recession.

Even before the full scale of the energy crisis, the Office for Budget Responsibility was predicting a budget deficit of £99 billion this year, but that has been overtaken by events. The highest forecast for the deficit this year among independent forecasters surveyed by the Treasury is £150 billion, and £130 billion for next year, 2023-24. Even these forecasts do not take into account the full extent of the fiscal support that will be needed during the energy crisis, which is likely to amount to many tens of billions of pounds, possibly even £100 billion or more before the crisis is over, and the revenue impact of the cancelled tax hikes if Liz Truss becomes prime minister.

The profile of government debt, properly measured, is not for the fainthearted. The squeamish should look away now. In 2007, the eve of the financial crisis, public sector net debt was just over £500 billion, or 33 per cent of GDP, well within Gordon Brown’s self-imposed “sustainable investment rule” ceiling of 40 per cent.

By 2010, under the impact of the crisis, the debt had almost double to nearly £1 trillion (£1,000 billion). By 2015, despite coalition austerity under David Cameron and George Osborne, it was up to £1.5 trillion, and 80 per cent of GDP, almost double the “stable and prudent” limit of a decade earlier.

The debt was nearly £1.8 trillion in 2019, having stabilised at around 80 per cent of GDP, but the next shock, the pandemic, pushed it up to a current level of just under £2.4 trillion, or between 95 and 100 per cent of GDP.

What happens now is anybody’s guess, but you would not bet against the debt hitting £3 trillion before too long, and for it to be six times its level in 2007, and for the new norm to be well above 100 per cent of GDP.

There is no alternative to adding to the debt in response to the current crisis, but it comes at the cost of a rising debt interest bill, in the absence of further quantitative easing from the Bank of England, which would be very hard to justify at a time of soaring inflation. When some currency analysts and traders say sterling has taken on the characteristics of an emerging market currency, the UK’s rising debt trajectory is part of the explanation.

Crises are not supposed to follow each other so rapidly. When they do, it is bad news.