Wednesday, 22 April 2009

The Party's Over...

...and here’s the bill. So now we know more clearly the cost of this bust (in which GDP is now forecast to fall some 3.5% this year) and it is shocking. Public sector net debt was 36.5% of GDP in the fiscal year 2007/8 and today the Chancellor has projected public debt to rise to just a shade under 80% of GDP by 2013/14. Public debt was previously as large as 80% of GDP in 1968 when the trajectory was still gradually adjusting downwards after WWII. This government’s self-imposed Golden Rule, or threshold, for public debt of 40% of GDP has been shattered with some £790Bn of borrowing planned over years from 2008/9 to 2013/14.

Admittedly, accompanying this debt projection are some plans for taxes to rise and for the growth in government spending to fall somewhat more than earlier plans. But these new plans represent second order modifications around a potentially explosive path. The risks to the path for debt to GDP seem to lie on the upside should the economy continue to remain longer in the doldrums and, which may follow, should there be further calls on the public purse to bail out financial institutions.

The big picture is that a large quantity of debt, created during the long 1990s expansion which ended in 2008, has now been transferred from the private sector to the public sector. And the trick that the public sector is trying to pull off is to smooth the increase in taxes that need to be levied on the private sector to pay-off these debts. But the danger is that financial markets will see through this trick and start to treat the public sector as more risky, like the hapless private sector, and that is why the initial reaction has been for bond yields to rise some 8-10bp. Now where’s that aspirin?