The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (10 page)

It is important to reflect on this. The company in question, GM, was the pioneer of many shibboleths of US corporate capitalism: consumer marketing and branding; specialised assembly lines; and the idea of shareholder value. But now GM was bankrupt. And the American government, dedicated to the free market, not only bailed out GM and the entire auto industry, it also got the votes for this in Congress. Obama’s vice president, Joe Biden, used this fact as the central tagline of his boss’s re-election campaign: ‘Under Barack Obama, Bin Laden is dead and GM is still alive.’ The strategy worked, delivering for the president the wavering rust-belt states, which have since experienced a boom in manufacturing jobs. It is true to say that not all in the USA felt the bailout was in keeping with American notions of freedom. Some conservatives organised a boycott of GM’s cars. And while many might disagree with the policy, the hand of the US Federal government in US capitalism had just become rather firm. The combined monetary and fiscal stimulus kept unemployment below 10 per cent (by 2013 it was below the rate in Britain). And by 2012, GM was planning an extensive foreign sales push and sponsorship of the world’s biggest football team. In America, the Stimulus Party was winning the austerity war.

Right from the beginning of his tenure as chancellor, George Osborne was asked why he was pursuing austerity while the US government was not. ‘I don’t have the world’s reserve currency,’ was his answer to me in early 2011. The chancellor was referring to what French presidents have called the ‘exorbitant privilege’ enjoyed by the USA of getting a large flow of global savings, rather cheaply, on the back of the dollar’s status as world currency. What worked for Washington would not necessarily work for Britain.

I happened to be standing outside the Treasury when George Osborne returned from Buckingham Palace in May 2010 having received the ‘Great Seal of the Exchequer’ from the Queen. At 38, Osborne was the youngest chancellor since the nineteenth century. His challenge was enormous. He had to balance the two coalition parties, and the different wings of those two parties. He had to take on Whitehall and the unions. And at the same time he had to contend with a broken banking system and the Eurozone crisis next door. In August 2010, he was at his peak – a colossus confident in his argument, bestriding government with his spending review, and displaying a missionary zeal for his fiscal plans. ‘It’s an absolute fundamental belief of mine that there is nothing progressive about losing control of the public finances, there’s nothing fair about it,’ he told me in his office at the Treasury, before listing centre-left and centre-right parties from the USA to Sweden that had cut back large deficits.

The Apprentice Chancellor had some advantages. He had carefully won the argument for some sort of spending cuts in advance of the election, although he had given very little detail of his plans for raising tuition fees, slashing the housing budget, cutting non-pensioner benefits, raising VAT, freezing public pay and hiking train fares. The financial markets clearly felt that a Conservative-led government had more credibility with the markets. Before the election, Osborne even managed to promise a ‘cut’ to a tax (in reality keeping employers’ National Insurance contributions unchanged) that was unfunded save for some amorphous ‘efficiency savings’. A Conservative could get away with that. Senior bankers, at that time, were claiming that ‘Ed Balls as chancellor would lead to a sterling crisis.’ Such is life.

Part of the early political strategy was to get the pain in early, and to blame it all, including the VAT rise, on Gordon Brown and Labour. That worked too. In fact, Osborne’s early ‘age of austerity’ rhetoric may have been a little too successful. Chris Williamson, the man who compiles the most closely watched measures of UK economic confidence, the Markit Purchasing Managers’ Index, told me in the fourth month of the coalition: ‘Our business measures have shown that since the June emergency budget, business confidence has collapsed and consumer confidence has collapsed.’ The US and Japanese economies were also faltering. Of greater concern, however, for Osborne and his coalition partners, were the verdicts of the respected Institute for Fiscal Studies, who had calculated that the new measures applied by the coalition were ‘somewhat regressive’. The new measures hit the poorest more than the richest.

There was a slight change of tack. Britain was in choppy waters, the chancellor said in a speech, but there were spots of good news. Doom was being replaced by ‘cautious optimism’. But within weeks, Britain’s economy fell sharply back into contraction, and would then cease to grow for over two years. The graph was striking. By March 2013, the economy had only grown 1.2 per cent in total since 2010, versus the 6.5 per cent predicted in the chancellor’s original deficit-reduction plan. A recovery from the depths of a terrible recession had been stopped in its tracks in mid-2010, around the time when Osborne took over the Treasury. The first figures revealing the contraction – minus 0.5 per cent in the last quarter of 2010 – were a huge surprise for the chancellor. He initially blamed it on the disruption caused by cold weather and heavy snow in December. But in Germany the weather had been worse and its economy had delivered strong growth. The British press mocked these ‘Snowmageddon’ excuses mercilessly.

Soon afterwards I spoke to Mr Osborne at the World Economic Forum in Davos. Normally, interviews with politicians at Davos take place outside, with a backdrop of glorious snowy mountains. But this year, British ministers, including the chancellor, were only to be filmed indoors, with not a flake of snow in view. ‘The fall in GDP according to the Office for National Statistics was caused by the very bad weather,’ Osborne insisted. ‘But David Cameron and I would like the GDP figure to be stronger, even without the snow. The truth is that we always said it would be a challenging recovery. We’ve had the deepest recession of our lifetime, the biggest banking crisis since the 1930s. There is a new government trying to sort out this mess. It was always going to be choppy.’ I asked him whether he would alter his plan if the negative trend continued. ‘I’m not in the business of speculation,’ he replied. ‘I look at the central forecast for the British economy, which is for sustained growth and for rising employment. And to make sure we take advantage of that by not going back into the financial danger zone I found when I came to office. Abandoning our deficit-reduction plan would lead to higher interest rates and a threat to our credit rating as a country.’ He spread his narrative of blame a little wider, when I gently pointed out to him that Germany seemed to be doing well, despite the snow. ‘Where we went wrong in the British economy,’ he said, ‘was the biggest budget deficit in the Western world. And our model of growth for the last ten years concentrated on one sector, financial services, in one part of the country, the southeast. I already know Germany has a better growth than us so I’m trying to get this country to manufacture, export and invest more so we have more sustainable growth, going forward.’

The last point was presumably intended to appeal to the LibDems in the governing coalition. The government started to make some extraordinary promises. ‘We’re actually starting to reindustrialise Britain,’ the prime minister told me on a successful trade mission to India, three months after taking office. Critics suggested that the government was attempting to make a virtuous strategy out of a brutal necessity to rebalance Britain’s economy. It would become a yardstick by which to judge economic progress. Throughout the 2011 Eurozone crisis, rising fuel prices and the impact of the hike in VAT would see a very bumpy recovery. International organisations such as the IMF, European Commission and OECD were revising down their forecasts for British growth – as was the chancellor’s own independent Office for Budget Responsibility. The result was that the expected cuts in the deficit were grinding to a halt amid disappointing tax revenues and increasing welfare payments. Borrowing remained stubbornly high.

Nevertheless, the chancellor managed to keep the IMF on side. When asked whether Britain should change its plan, the IMF’s handlebar-moustachioed interim managing director John Lipsky emphatically said ‘No.’ But the VAT rise had added to inflation in Britain, helped reduce real take-home pay, and impacted on consumer confidence. In May 2011, while returning from a Eurozone crisis summit in Brussels on the Eurostar, the chancellor told me: ‘The Bank of England argument… is that inflation is set to fall next year and the year after. The VAT rise is an essential part of dealing with the budget deficit.’

The message, even as the economy ground to a halt in July 2011, was that the chancellor was ‘absolutely not for turning’. ‘If we were to abandon our deficit reduction plan,’ Osborne said, ‘if we were to borrow more, I think most people in the rest of the world would think we had gone completely mad.’ The coalition had created ‘a safe haven in the storm’. Yet the public finances were off track, and the prospect of yet more cuts or tax rises loomed. By the end of 2011, there had been a very telling change of course. The chancellor’s plans were a little less binding than they had appeared. There was flexibility built into the borrowing targets, in precisely the same way that Gordon Brown had fudged similar targets. Osborne abandoned the plan of having the deficit dealt with by the time of the next general election, postponing further austerity until the next Parliament. There was no ‘chasing the targets’ with more cuts and tax rises. And at the end of 2012 he pushed the target even further into the future, and for good measure he also parked the requirement for falling debt. These were hugely important moments. Essentially the chancellor accepted a level of borrowing that was much larger than expected, rather than inflicting more immediate pain. But he did not shout about it. The markets were unaffected. He was spending some of the credibility he had earned with the bond vigilantes from his tough austerity rhetoric. Bond yields remained at record lows. Credit-ratings agencies, though, began the process of downgrading Britain. By March 2013, Britain was borrowing £703 billion over six years 2010–2016, instead of the £471 billion forecast in George Osborne’s June 2010 Emergency Budget. The political argument in Britain revolved meaninglessly around ‘sticking to Plan A’ or ‘the need for a Plan B’ – the Opposition’s plan for a Keynesian borrowed stimulus of tens of billions of pounds. It turned out that Plan A was so flexible that it was consistent with hundreds of billions in extra borrowing. In the Venn diagram of fiscal planning, B was a wholly contained subset of A. Still, announcing some £232 billion of extra borrowing over six years generated barely a flicker of interest from the markets. What was this strange hypnotic hold that George Osborne had over the bond vigilantes?

At the Debt Management Office, a tiny band of salesmen auction off what should be the safest bet in the land – British gilts. British government bonds are known as gilts because of their safety. They have always had an AAA rating because of the UK’s standing in the world, and its fiscal stability. I visited the DMO in 2009 just days before the ratings agency Standard & Poor’s started the process of downgrading Britain, after the collapse in UK tax revenues under Gordon Brown. The DMO is tucked away in Philpot Lane, a side street in the City close to the Monument. It does not have a grandiose edifice like the Bank of England or the Treasury. It does not even have its own building. Occupying just two floors are the trading desks where Britain finds the necessary funds when the government spends more in a year than it taxes. This happens more often than not, and has been happening non-stop now for over a decade. The DMO has also subsumed various historical statutory bodies such as the Commissioners for the Reduction of the National Debt (CRND) – whose last minuted meeting was in 1860 – and the Public Works Loan Board. It also operates other government auctions, such as the EU carbon-trading scheme, and the business-loan guarantee scheme. The CRND was established to oversee William Pitt the Younger’s dedicated ‘Sinking Fund’ for paying down the national debt in 1786. It still functions as the vehicle through which ‘a few public-spirited people’ give or bequeath money or property to the nation, and the proceeds are then used to cancel gilts. It will not be Britain’s primary route out of its debt maze. But the activity on the trading screens of the DMO, particularly at 10 a.m. on a Thursday morning, will determine the parameters of politics in Britain for years to come.

On my visit, the traders had just borrowed £700 million from the markets for thirty-eight years, by effectively paying a real yield of 0.78 per cent. The gilt is ‘index-linked’, meaning that the coupon payment and the principal sum are adjusted in line with movements in the Retail Price Index. This takes away the risk posed to a bond-buyer’s returns by future inflation. The bond did well. Bids worth two and a half times the required lending were offered to the DMO. In the jargon, it was ‘well-covered’. The nightmare is that one day an auction, or series of auctions, will be left ‘uncovered’.

In the wake of an inconclusive election, as government borrowing hits unprecedented levels and borrowing targets have been repeatedly missed, a niggling question arises. Can the DMO traders find buyers for all these bonds? Even in 2009 the DMO’s head, Robert Stheeman, was attentive to the risks, but at the same time notably relaxed. ‘Aren’t you getting concerns from potential buyers?’ I asked him. ‘Not directly,’ he replied. ‘We are asked questions about the direction and where things are going. But at the same time a lot of the holdings come from highly sophisticated official institutions, and they don’t seem to express undue concern.’ What about the threat to the AAA rating (which was made the following week). ‘A credit rating is ultimately just that. An opinion by the credit-ratings agencies.’ If there was an effect, he said, ‘it is much more likely to be expressed in price, and it could be imperceptible’.

That was the case in 2009, and it remained the case all the way through to 2013. Record low bond yields in Britain did reflect the fact that the country, despite its large and stubborn deficits, was considered a safe haven, especially during the Eurozone crisis. Certainly the chancellor’s tough austerity rhetoric helped. However, the bond vigilantes had largely been disarmed in the USA and the UK. A large chunk of Britain’s gilts were being bought a few hundred metres away from the DMO at the Bank of England under its programme of quantitative easing (see Chapter 9,
here
). The market value of Britain’s total stock of debt was £617 billion at the end of 2008, and that had more than doubled to £1.35 trillion at the end of 2012 – an increase of £741 billion. More than half of this increase (in fact 56 per cent of it) was explained by the increase in what was owed by the Treasury to the Bank of England, so that by the end of 2012 the Bank owned 29 per cent of the total debt stock of the UK. In effect the Bank of England was funding the equivalent of Britain’s entire national debt in mid-2005. The market for gilts has basically been rigged by a monopoly buyer with access to unlimited central-bank funding. The bond vigilantes have not been hypnotised, they had no power in Britain, and so focused on the Eurozone periphery.