Once Britain loses its AAA rating, the coalition is likely to break down
The government's key economic message has been that it is taking tough decisions to keep the confidence of the bond markets. A cut in our triple-A rating could blow that out of the water, and the coalition may not be able to take the strain, says Matthew Lynn.
How much longer can Britain remain AAA-rated? America isn't anymore, neither are Japan and France. It seems impossible that Britain can remain in the small group of most credit-worthy nations for much longer. The economy is stuck in recession and shows little sign of recovery. Tax receipts are falling short of expectations and cuts in public spending are slow to materialise. If that isn't a recipe for a ratings cut, it is hard to know what is.
In normal circumstances, Britain might be able to shrug that off. Losing triple-A status didn't make much difference to America or Japan. But David Cameron's coalition government has staked its credibility on preserving the rating and with it the confidence of the bond markets. Once this is gone, the coalition could easily fall apart. The markets will support double-A rated countries with stable, secure governments. It is much less likely that they will support double-A rated countries facing political chaos.
The club of triple-A countries is getting smaller. Germany is still there, although even it is on negative watch ratings agency code for watch out, we're about to downgrade you next'. Switzerland is still safe, of course, as are Finland, Norway and Sweden, along with the Netherlands, Canada and Australia. Hong Kong and Singapore make the cut too. But that is about it. It is a very select group, composed of countries with decent growth rates. Most have stable and well-capitalised banking systems, trade surpluses and welfare, health and pension systems that are properly funded and don't have big open-ended liabilities.
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Britain sticks out like a 60-year old at a One Direction gig. There is nothing stable about the government's finances. This month we learnt that it had to borrow £600m in July, although it is traditionally a very strong month for revenues. There was a drop of 0.8% in tax collected, with corporation tax in particular very weak. Four months into the financial year and the government has already borrowed £44.9bn £9.3bn more than in the same period in 2011. In a report this week, the Centre for Policy Studies argued that the government would fail to meet its target for bringing the deficit under control within the lifetime of this parliament. Only 6% of the coalition's targeted reductions in current expenditure have been achieved so far, it said. Overall, it forecast that the official national debt will rise by £605bn over the course of this parliament, or from 53% of GDP in 2009/2010 to 76% of GDP in 2014/2015.
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If growth continues to disappoint, it could get worse. Rising, persistent debt levels and near permanent recession, or at best sluggish growth, are a lethal combination for debt ratios (just ask the Italians or the Spanish). Neither Italy's nor Spain's government has been very extravagant in the past few years. But if an economy refuses to grow, it's hard to stop the debt-to-GDP ratio rising inexorably.
Meanwhile, we run a huge trade deficit. Our personal and corporate debt runs at some of the highest levels in the world. We are fanatically committed to a free healthcare system that exposes the government to vast, open-ended expenditures as the population ages. Our welfare system, despite some tinkering, devours an ever-rising proportion of national income. Generous public sector pensions, none of which are properly funded, are an open chequebook for future generations. Half our banking system is virtually in state hands, and the other two mega-banks are a potential liability: one crazed trader at Barclays Capital could put another £100bn on the debt pile in an afternoon. Perhaps most significantly there is no public appetite for austerity. Despite the fact that cash spending is still rising, the debate is all about whether the government should be spending more.
So a ratings cut is not a matter of if' it is simply a matter of when'. No sane person can put Britain in the same league as Australia, Finland or Hong Kong. In most circumstances, that wouldn't matter too much. There was a huge fuss when America lost its triple-A rating last year. But it has not made any difference to the country's ability to borrow money on the markets. It was the same story with France, which lost its triple-A rating in January. Japan still funds huge deficits, despite having lost its rating years ago.
Britain might be different, however. Stabilising the nation's finances and tackling the deficit was the entire raison d'etre for the coalition between Nick Clegg and David Cameron. It allowed both men to sell the deal to reluctant parties. The key economic message has been that the government is taking tough decisions to keep the confidence of the bond markets. At a stroke, the rating agencies could blow that out of the water.
Could the coalition take the strain? Perhaps, but it might fall apart. Then the bond markets could well take fright and Britain would have no effective government. It would face an election at which the main opposition party was baying for more spending. Plans for reducing the deficit would lie in tatters. A ratings cut needn't do much damage to a stable country. But if it faces political chaos as well, then all bets are off.
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Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years.
He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.
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