First published in the Telegraph on 3 June 2010
Since more or less the dawn of time, the British have loved to present themselves as that bit better – and better-off – than their counterparts overseas. Back in the 19th century, Gustave Flaubert’s not entirely sincere definition of Englishmen in his satirical Dictionary of Received Ideas was: “Tous riches”. Yet at the same time, there has been a perennial strain of national insecurity, a worry that we are being eclipsed by other, better organised nations.
To see this tension in action, consider the events of the past few weeks. The disaster in the Gulf of Mexico has dealt a colossal blow to the prestige of British business, with President Obama spitting tacks, Union flags practically being burnt in the streets of Louisiana, and the firm’s share price – and many of our pension pots – plummeting. Prudential, which launched an audacious raid on the Asian business of fallen giant AIG, has seen its plans fall apart amid a humiliating shareholder revolt.
Yet on the economic side, George Osborne finds himself in rather a better position than he might have expected. Not so long ago, it was fashionable to opine that the UK would be the next shoe to drop in the great financial crisis. Now the euro project is crumbling, provoking quite a run of Schadenfreude on this side of the Channel. As Greece, Portugal and Spain face crisis after crisis, Britain has somehow established itself as a safe haven. The interest rate on our 10-year gilts – a pretty good yardstick of whether investors think you will default (either through inflation or outright refusal to pay entirely) – has dropped from around 4 per cent to just over 3.5 per cent in the past few weeks. Growth rates in the British economy are expected to outstrip those of its sickly European neighbours; tax revenues are coming in faster than expected, grinding away the deficit even before the Chancellor has to do much of the hard work.
So strong is his apparent position that Mr Osborne will tomorrow warn his fellow finance ministers at the G20 that they, too, cannot waste any time in cutting their debts, pointing to his new Office for Budget Responsibility as a model to emulate (in much the same way as Gordon Brown once lauded his flawed model for regulating the financial system).
So what is the true position? Assuming that external shocks – such as a recession in Europe, a sovereign default in Greece or (far, far worse) an implosion in Spain – do not derail hopes of recovery, can Britain really justify lecturing others about economic management? By many yardsticks – size of annual government borrowing, severity of the credit crunch, depth of recession – Britain is in as deep, if not deeper, trouble than most of those euro members. However, financial markets, like the rest of us, find it hard to focus on more than one thing at any time. Since Greece’s near-collapse, they have been fixated on a very specific problem, namely that over-indebted euro members cannot easily buy time for their economies by devaluing their currencies, because they are stuck in the straitjacket of euro membership.
As a result, countries with an independent currency have become refuges of sorts. There is a decent rationale behind this: for a start, the likelihood of our being unable or unwilling to pay back our debts is extremely slim. Britain has not defaulted on its domestic debt since Charles II refused to pay interest on some bank loans in 1672 – the “Stop of the Exchequer”.
We have been able to do this because countries with their own currency and monetary policy can usually erode their debts away by generating inflation. Britain has done so on countless occasions throughout history. Markets seem to prefer this “soft” option, perhaps because it leaves a country’s destiny in its own hands. Moreover, the maturity of British government debt is by far the longest in the world, so we do not have to reissue it year after year. That is why Britain is due this year to issue less debt than Germany, despite the far larger size of the UK deficit.
These, for Mr Osborne, are happy accidents. But they cannot disguise other, more ugly features of the economy. While most investors have happily fixated on Britain’s advantages, they have conveniently forgotten the fact that around four fifths of the Government’s liabilities are linked to inflation (including both our index-linked bonds and off-balance-sheet nasties such as public sector pensions and the costs of the Private Finance Initiative). Eroding our national debt significantly without cutting back (in particular, state and publicsector pensions) would take a bout of hyperinflation, which would have all sorts of consequences.
A small band of hedge funds is now building up a series of sizeable bets on Britain defaulting. In the past few weeks, they have placed more than $3 billion worth of bets on that precise outcome in the credit default swap market. History – three centuries without default – suggests that they will be proved wrong. But these are unprecedented times. Had Britain joined the euro, it would certainly have shared Greece’s fate, and would have been too big to be bailed out.
Avoiding euro membership, however, will not guarantee that Britain avoids default. We cannot afford to be smug for ever.