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We knew that governments were spending a lot of money on the coronavirus outbreak and lockdown. But even so, when you get to see just how much it is, it’s quite a shocker. The latest report from Britain’s fiscal watchdog is out and it makes it very clear just how big a crisis this is. The bigger question though for investors, is this: how is it all going to be paid for?
Our fiscal watchdog has some very big numbers for us to look at
The Office for Budget Responsibility (OBR) is the UK’s fiscal watchdog. Like many such institutions, it was set up with a political purpose.
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It was launched in May 2010 after the UK’s coalition government had come to power in the wake of the financial crisis. Its job was to give an independent view of the public finances at a time when the state of Britain’s finances was a huge political football.
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To be clear, this is not to question the OBR’s independence. It's been very clear over the years that the OBR is not afraid to put out numbers that the party in power would otherwise not want to hear. However, it’s worth bearing in mind that its purpose was at least partly to give voters the idea that the public finances were being managed responsibly at a time when the global financial crisis had us all worried about sovereign debt and the possibility that countries would go bust.
It’s interesting how far we’ve come in just a decade. The OBR just put out its "fiscal sustainability report” for the year. This year, public sector net borrowing (the deficit – the gap between what the government gets in taxes and what it spends) looks set to come in at between 13% and 21% of GDP.
For comparison, the European Union is supposed to sanction countries if they have a deficit of more than 3%. In practice, they don’t of course, but it gives you an idea of what’s considered “a lot”.
For a scarier comparison, the deficit after the 2008 financial crisis hit about 10% of GDP. So even at the low end of estimates, the UK is looking at a deficit this year which is greater than at any time since World War II.
We all knew that the government was spending a lot, and we all knew that this was a crisis, but that is really quite striking when you put figures on it.
The political environment has moved a long way away from austerity
Now, the OBR – sensible fiscal watchdog that it is – is concerned about how we’re going to pay this back. “In almost any conceivable world there is at some point likely to be a need either to raise some taxes or to reduce some existing spending commitments to accommodate new ones… and to put the public finances onto a sustainable long-term path.”
However, as I said, we’ve come a long way in a decade. In 2010, austerity was, if not exactly a vote winner, certainly seen as a necessary evil. The banks were bust. The government was broke. The euro was about to be stricken with a sovereign debt crisis (that was for structural reasons, but these things spill over psychologically).
Times have changed.
Nowadays, it’s a different world. Nowadays, everyone is talking about Modern Monetary Theory (MMT) and how the only restraint on countries with their own currencies is inflation. So until inflation takes off to an economically-ruinous extent (which the MMT-ers basically equate with full employment or thereabouts – it’s more complicated than that, but then, so is everything with MMT), we can spend what we want.
Now I’m not convinced that it’s as easy as that. The last ten years have shown that you can certainly print a lot more money than we’d ever have expected. But then, the last ten years have been in the wake of a massive banking crisis. That’s not the case any longer.
However, as an investor, your view on the accuracy of this is entirely by-the-by.
The OBR might think we need higher taxes or lower public spending at some point in the future. But right now, I can’t see a world where voters are happy about that idea.
How do you get rid of the debt without actually having to spend less or tax more? You deploy the magic inflationary wand alongside financial repression. In other words, you make sure that prices rise faster than interest rates for a prolonged period of time.
This is generally bad news for cash savers but it’s good news for debtors and also for the owners of some assets (inflation makes their prices go up).
The OBR has its concerns about this idea too, of course. “The government’s ability to push the deficit ever higher rests in part on the credibility of the institutional framework that gives investors confidence that the value of the government bonds they purchase will not be deliberately eroded in the future.”
However, I suspect that this is a risk the government will be prepared to take. And not just our government – government all around the world.
This political risk is the primary reason why I think that coronavirus will turn out to have been more inflationary than deflationary. Because if it’s not, we’ll just get more spending and money printing until it is. That implies in turn that you need to consider the impact of inflation on your portfolio.
You can read more about MMT in the next issue of MoneyWeek magazine, out on Friday. If you haven’t subscribed yet, then get your first six issues absolutely free here.
