Friday, 5 February 2010

After the Bail Out - The Hangover

We will all remember only too well the almost gleeful way in which the various media reported the financial crisis as the enormity of the problems facing us emerged. There seemed a time when journalists and commentators were trying to outdo each other in their predictions of how bad things would get. The debate seemed to be over the number of decades the coming depression would last.

In truth, nobody really knew even what was going on at the time, let alone what was likely to come as a result, but of course it did sell plenty of newspapers. However, we now know that the longest lasting legacy of what happened is going to be the unimaginably large amount of debt that we have been signed up to as a result of the ensuing ‘Bailout’.

It is difficult to be sure just what the impact of this debt might be, as we don’t yet know the full extent of it. More importantly though, how the world’s debt markets will view our creditworthiness into the future is going to have a significant effect on our way out of the mire.

A recent European Union Commission report pointed to the UK having a ‘sustainability gap’ of 12.4% of Gross Domestic Product (GDP), which represents almost twice the average figure across the EU. The report concluded “The UK appears to be at high risk with regard to the long-term sustainability of (its) public finances”, and reckoned that the debt-to-GDP ratio would rise from 2007’s 52% to well over 200% by 2025.

Share prices have for the most part bounced back and are in rude health once more, though it remains to be seen how much of this is as a result of an asset price bubble induced by the extra funds from Quantitative Easing. However, the debt that remains needs to be tacked in a concerted manner if we are to creep back to solvency and indeed if we want to retain our ‘Triple A’ credit rating.

The paralysis in government that we have endured since embarking on this vast odyssey of borrowing does nothing for the confidence of debt markets. As a result we need to come out with plans that make it very clear just what we are going to do to address the problem. Essentially, it is not rocket science – we need to balance our income and expenditure in such a way as to begin to repay the debt. However, without a booming economy, ‘income’ from tax revenues can only be increased by raising the taxes themselves, risking choking off whatever spark of life might be returning to activity. Similarly, the other side of this equation is expenditure, which can and probably should be cut significantly. However, this too can have the same unwelcome effect and we at all costs want to avoid the scenario that Japan endured throughout the 90’s and well into the decade we have just left, where government could not get to grips with this balancing act and inflicted the ‘lost decade’ on their people instead.

Whatever, we do have to have the courage at least to pin our colours to the mast by stating what we are going to do and when. A clear and published plan of attack is what is required, as it will let economists and public alike know what they can expect from the coming years.

One thing is for certain: Prudence left the building some considerable time ago.