Alasdair Macleod – 11 June 2010
David Cameron is doing an excellent job of changing the political agenda towards cuts in public sector spending. The public, partially informed by the misfortunes of Greece, now accepts that deep cuts in public spending have to be made. Cameron’s political timing is lucky because of Greece, and the whole of Europe is now following a similar agenda.
It must always be remembered that Europe and all other developed economies face the same difficulties at the same time. We do not have the luxury of global stability while we correct errors of the past. We are all afloat, or all swimming, to a greater degree than in the thirties, and this is a time of financial crises.
The Keynesians argue that cuts in public spending will lead to job losses, even extending to the private sector businesses through cancelled government contracts. The consequence will be that the recovery, necessary to restore public finances, will be aborted. Furthermore, with all Europe now embarking on cuts in public spending, the timing could not be worse. But rather than debate the flaws in Keynesian economics, we must accept, as the stock markets seem to indicate, that a period of cold turkey is the inevitable consequence of public sector cuts in both the UK and Europe.
Dealing with the Alice-in-Wonderland world of Keynes is only one aspect of the problem, the other being monetarism, or put another way the printing press operated by the Bank of England. Here, the precedent is not good: politicians can occasionally understand things like public sector finances, but matters of money and credit is a bridge too far. The most dramatic example of this was America in the twenties. President Coolidge contained taxes and government spending admirably; but he was blissfully unaware of the Fed’s expansion of credit, which fed Wall Street’s boom and subsequent bust, tragically negating all the good he did. Now that the Bank of England is independent, it has the same destructive scope and it is almost certain that this vital aspect of economic management will be left to it by Whitehall.
Indeed, we are already aware of early signs of the Bank preparing to “accommodate” the tighter fiscal position through an extension of easy money policies. Doubtless, when the scale of the spending cuts is revealed in the forthcoming budget, the Bank will be able to announce the next round of quantitative easing. This will almost certainly be hailed by the City as a triumph of economic management, and for a time it might appear so. By cutting public spending early and balancing it with quantitative easing, the UK will be the envy of Euroland states, which are forced to do the former but cannot do the latter. But rather than debate the flawed logic of monetarism, we should only observe that monetary inflation, that panacea for all our ills, continues to accelerate on its hyperinflationary course.
Meanwhile, in America President Obama is still throwing money at everything that shows the slightest signs of life. Spendthrift America is now noticeably out of step with her G10 partners. Blessed with Keynesian luminaries such as Paul Krugman, she is still preying for an upturn to reduce the Federal deficit, but close examination shows her economy is actually in serious difficulties. Headline GDP numbers for the current fiscal year are expected to grow at about 3%, but within this figure growth in the public sector component is running at 7.6%, and the private sector is actually contracting at 1.2%. Furthermore, correcting the private sector figure to account for domestic money inflation makes the true position one of severe contraction in real terms, as outlined in my note dated 1 June.
The truth is that the private sector is still in a slump the likes of which have not been seen since the Great Depression. This explains why real unemployment in the States today is at similar levels of about 20%. No wonder governments like monetary inflation, it is so effective at hiding the truth.
So David Cameron may be doing the right thing by reducing public expenditure; but unfortunately he is too late to change the outcome. It is ironic that these cuts will almost certainly accelerate monetary inflation. And there is no one to underwrite us through our period of adjustment.