Comments on the UK budget

Alasdair Macleod – 27 June 2010

A number of people have asked for a general opinion on the UK government’s recent budget proposals, so the purpose of this article is to provide it.

The budget seeks to reduce the deficit at a faster pace than anticipated under the previous (Labour) administration, and it places less reliance on economic growth as a means of deficit reduction. This change in policy with respect to the role of economic growth in reducing the deficit has been justified by the escalation of risk for profligate governments, as demonstrated by Greece. It is also suggested that a greater emphasis in this budget is placed on a reduction of government spending than proposed by Labour, but in fairness the comparison is with a budget that will never be delivered, and the actual spending cuts have yet to be defined.

The political background appears favourable for a change in these economic policies. The headlines are as stated above, but the sub-text perhaps is a Conservative ambition: the long-term reduction in the role of the State in the economy. While this sub-text is laudable, and can easily be proved to be economically sensible, it cuts across the socialists – the Labour and Liberal Democrat parties – who believe in more state intervention and that the profit motive is morally dirty. Furthermore, many on the Conservative benches pay lip-service to the concept of a smaller state, but through the promotion of their own hobby-horses actually seek to expand it. So we should assess the durability of the coalition that has produced this budget, and the likelihood it will actually be implemented.

The coalition has surprised everyone with its authority, and it has created a genuine feeling for many that co-operation under a good leader is the best hope that Britain’s economic problems can be addressed and resolved. But the sole reason for this unexpected political success is that there has been such a change in the status quo that the forces of opposition are in disarray and silenced. It is therefore only a matter of time before these forces recover their poise, make coherent objections to spending cuts and obtain the backing of public opinion. Objectors have until the autumn for this easy task, when the spending review is due to be completed; so we can expect political squabbling to escalate within this time-scale. To the extent that the opponents succeed, spending cuts will be limited, while tax rises will go ahead or even be increased further to compensate.

This cynicism has the support of experience. The developing debate will be against a backdrop of the general economic background, both in the UK and elsewhere. If the economy performs as forecast in the budget, the public will need persuading the cuts in welfare payments are still required. If the economy shows signs of picking up in the coming months, there are those who will question whether cuts are actually necessary. If the economy deteriorates, economists will succeed in injecting considerable doubt into the process by playing the deflation card. The likelihood of the budget being fully implemented as intended is therefore far from certain on political considerations, and there is also a significant possibility the coalition itself will not survive, because it is narrowly based on the ambitions of the few Liberals who have obtained power through it.

Turning to economic considerations, the budget measures are totally inadequate. To be effective, a determination to radically reduce the economic resources that are tied up by the state is required, not to only reduce the budget deficit. In this context, the budget proposals only address the pennies. There is therefore little difference between British economic policy and those of her statist neighbours, and Britain’s relative financial standing is not therefore materially improved. In common with spending proposals emanating from the Euroland states, there is no meaningful transfer of economic resources to the private sector intended, which with a return to sound money policies is the sine qua non for a true economic recovery.

Monetary policy had no mention in the budget, a consequence perhaps of the total delegation of these hard-to-understand matters to the Bank of England by Gordon Brown. The result is that the short-term and negative effects of spending cuts will most probably be counterbalanced by greater monetary easing. This is a course already recommended by City economists, who are concerned that deflation is a growing risk, given spending cuts proposed both domestically and in Europe. But these monetarists never fully consider the true consequences of money debasement, nor do they appreciate the importance of sound money.

It is, after all, the expansion of credit through the banking system that created the consumer bubble and the ensuing financial crisis in the first place; an expansion that was facilitated not only by the gearing of bank balance sheets but also because the whole banking system is underwritten by the central banks. Lending excesses had no natural limit other than the inevitable rise in interest rates. The economic and financial distortions that have built up over time have now become so great that to allow them to unwind would simply bankrupt the whole banking system. For this reason the global policy option employed has been to attempt to inflate away the problem, and in the UK this has not changed with the change of government.

The reality is that the budget will resolve nothing, because there are far larger economic dangers than those the budget attempts to address. None of the measures proposed can change the course of events.

Macbeth put his finger on it: “And all our yesterdays have lighted fools the way to dusty death.” And to paraphrase further: “The Chancellor is a poor player who struts and frets his hour upon the stage and then is heard no more. The budget is a tale, full of sound and fury, signifying nothing.” Students of Shakespeare will understand and excuse the small omission from the last sentence.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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