When the government borrows, who does it borrow off? This question from a reader arose in response to Monday’s crisis budget, when chancellor Darling announced record sums of borrowing. It’s an arrow that gets straight to the heart of the problem.
The straightforward, short-term answer is that the government offers to borrow money from anyone who wants to lend it. In exchange, it offers “government bonds” or gilts, the original form of securities which, in the old days, were considered relatively low risk, because they were guaranteed by the state. And, so the theory went, governments can’t go bankrupt, because they control the issue of money – one of the many forms of credit.
In the longer term, there’s the question of paying the loans back, with interest. Governments raise the money to repay borrowing by taxing the creation of value, and value is created when people work, by the people who do the work. But the historically unprecedented scale of the expansion of credit over the last 30 years has changed things out of all recognition.
Now Martin Wolf, chief economics commentator at the Financial Times, says “the horrific numbers” in the pre-budget report might well lead to a questioning of the creditworthiness of the UK government. “A creditworthy government”, Wolf says, can shift excess debt from the private sector on to the backs of taxpayers. An uncreditworthy government cannot. If the cost of debt becomes too high, the latter will be forced into default, either openly or via inflation. In the UK’s case, inflation would be triggered by a flight from sterling.”
In other words, if the government is unable to raise the money through taxes to repay the “horrific” level of borrowing it will be in default, be bankrupt, become a failed state. A bit like Zimbabwe. In fact, the markets are already beginning to consider this possibility. The cost of insuring against the British government defaulting on its gilts in the next five years surged this week.
Darling makes assumptions about the future trajectory of the economy that don’t impress anyone. Wolf says “…the Treasury surely remains too optimistic: despite the scale of the shock to the world economy and the financial system, it assumes an annual peak to trough decline in GDP of a mere 1 per cent; an economic recovery in the second half of next year; and then a return to trend growth at 2¾ per cent a year, despite the need to shift output into capital-intensive, export-oriented manufactures. This is not plausible.”
That’s putting it mildly. The effects of the crisis have already erupted onto the high streets with big names Woolworth’s and MFI in administration, Curry’s and PC World making big losses. In and around Llantrisant, the home of the Royal Mint in Wales, hundreds of jobs have been blown away in a few hours, in Bosch car components, Oreal and Budelpack cosmetics, Hoover, the Serious Food Company and Ferrari’s – a chain of bakery shops.
Yesterday, representatives from the building industry and car manufacturers got to the head of the queue of those trying to persuade the government to help them stave off bankruptcy. They went away empty-handed, apparently. The government’s tax income is destined to fall off sharply for years to come.
There’s a bit more to this excellent question. Earlier attempts to raise impossible levels of taxes have produced social unrest and political change. In 1381, the most extreme and widespread insurrection in English history, the Peasant’s Revolt, was triggered by the poll tax. It was the beginning of the end for a society based on exploitation through landownership. Attempts by Charles I to raise money without recourse to Parliament contributed to the English Civil War and his execution in 1649. On March 31 1990,there were riots in London against the Community Charge, commonly known as the poll tax. Watch this space.