UK downgrade: No alternative to stagnation
Britains credit rating may have been downgraded, writes Eddie Ford, but in reality that was more a judgement on the state of the world economy
Well, it finally happened. Not that you had to be a genius to predict it. For the first time since 1978, the UK has been stripped of its triple-A credit rating. Explaining its decision on February 22 to demote the UK by one notch to AA1 status, Moody’s rating agency - with a certain amount of logic - has concluded with “increasing clarity” that the UK’s economic performance will remain “sluggish” for at least the next few years due to the “anticipated slow growth” of the global economy. No country is an island.
As a consequence, Moody’s continued, the government’s debt reduction programme faces significant “challenges” ahead - namely, the UK’s “high and rising debt burden” and a deterioration in the “shock-absorption capacity” of the government’s balance sheet, which is “unlikely” to be reversed before 2016. In other words, the UK looks less of a safe bet now - even if Moody’s thinks that the country still has “significant credit strengths” and classifies its future ratings outlook as “stable”. There are now only a handful of members of the triple-A club, and some of those remaining are currently on “negative outlook”. France lost its pristine status last year and the United States was downgraded by a notch at the end of 2011.
In that sense, Moody’s verdict was more of a judgement on the state of the world economy than the British one - though in a way it represented an indictment of the coalition government as well. Realistically speaking, in and of itself the downgrading will not necessarily have a huge economic effect - perhaps next to nothing. Yes, there has been excitable speculation in some quarters about a run on the pound or a sterling crisis, but that seems unlikely.
Sure, in the short to medium term the UK government might find itself having to pay slightly more to borrow on the open market - but even that is not totally inevitable. Look at what happened to the US government when it was downgraded. Paradoxically, its interest rates actually fell. Investors, quite rationally from their perspective, took the downgrading as an assessment (or prediction) of the global economy as a whole and became very concerned. So, looking for a safe haven, they piled their money into … yes, the US. Not because its economy was a runaway, rip-roaring success, but rather due to its status as the only super-power: the world hegemon, the super-cop. The dollar might be mighty, but the US military is even mightier - at least a quadruple-A rating.
In fact, when the markets opened for trading at the beginning of the week, the pound did not take any great beating. Investors, obviously, long knew that the downgrade was coming and had already factored in such a development. Indeed, if anything, there are some indications that sterling is marginally benefiting from the ‘perverse bounce’ that the US experienced - though whether this turns out to be short-lived is near impossible to guess.
True, on February 25, shortly after markets opened in Asia, sterling dropped to a two-and-a-half-year low against the dollar. However, it quickly recovered. As for the FTSE 100, though, it actually rose around 40 points. More revealingly still, Britain’s borrowing costs are presently lower than they were before the downgrade. So on February 22 government yields were at 2.107%, but by February 27 they stood at 1.95% - a drop, temporary though it may be. Not too unlike what happened to the US, arguably.
But what is certain is that the UK will have to wait a long time before rejoining the elite pack. Canada lost its triple-A rating in 1992 and did not get it back for another 10 years - and that was the quickest any country was returned to its former status. For example, Australia lost its triple-A status in 1986 and did not get it back until 2003 - stuck in the credit ‘wilderness’ for 17 lonely years Then again, in the opinion of Yannick Naud of Glendevon King Asset Management, by every objective economic indicator the UK “should not have been rated AAA anyway” - count yourself lucky that you managed to stay in the club for so long. He estimated that the British government might have to wait up to 18 years to return to the fold. Get used to it. A point also made by the minister without portfolio and former chancellor, Kenneth Clarke. Avuncularly, he told Sky News that it is “going to take several more years of this” not only to be returned to the top rating, but also to “get back to sensible economic growth”.
Like anyone possessing a modicum of intelligence, or not totally blinded by dogma, Clarke realises that there will be no sharp upturn in the economy - definitely not before the next general election. Which is very bad news indeed for George Osborne and the government.
Whatever the possible economic ramifications of the Moody’s downgrade, it is a serious political blow for Osborne - if not a humiliation. How to get the egg off his face? Unluckily for him though, the entire world has not been struck down by amnesia - we remember what he has said. He made a fetish of protecting the UK’s “gold-plated” triple-A.
Just look at his record. Back in 2009, the glory days of opposition, an indignant Osborne called on Gordon Brown to take the country to the polls after Standard and Poor’s put the UK on “negative outlook” - what criminal economic folly! Vote Labour if you are stupid and want to lose our precious top rating. Osborne almost sounds like Gollum. Then in February 2010, he told an audience of Tory activists: “What investor is going to come to the UK when they fear a downgrade of our credit rating and a collapse of confidence?” Good question, George. In the Tory manifesto, published weeks later, he boasted about how the Tories will “safeguard” Britain’s credit rating with a “credible plan” to eliminate the bulk of the structural deficit over a parliament - seems like economic science fiction now. A year after taking office, the UK was taken off that negative outlook - leading a joyous Osborne to proclaim that, “thanks to the policies of this coalition government”, the country was enjoying “economic stability again”. And as recently as last July he declared that “despite the economic problems we face, the world has confidence that we are dealing with them”, thanks to the triple-A rating - a vote of confidence in the coalition government by the markets. You can always rely on the Tories.
Now it is a different story, of course. Osborne wants to have his cake and eat it. Far from being a sign of economic failure, an indication that there might be a flaw in the plan, Osborne is making out that losing the triple-A status - previously the unimaginable - only proves that the government must stick to its guns. Not in denial, but rather a man who just enjoys a drink now and again, Osborne said Moody’s decision was a “stark reminder” of the debt problems facing the country and that, “far from weakening” his resolve, it actually “redoubles” his determination to follow the same plan. There is no alternative to austerity and stagnation. Quite the opposite. What is required is more cuts and sooner cuts. Time for plan A+. As Simon Jenkins put it in The Guardian, Osborne - just like his European counterparts he so disparages - is akin to an Aztec priest at an altar: “If the blood sacrifice fails to deliver rain, there must be more blood” (February 27).
Quick off the mark, shadow chancellor Ed Balls dubbed Osborne the “downgrade chancellor” - echoing the late John Smith’s memorable description of John Major in 1992 as the “devalued prime minister of a devalued government” after Black Wednesday. Balls correctly noted that Osborne was adopting a “completely illogical” position: he has gone from “saying he must stick to his plan to avoid a downgrade to saying that the downgrade is the reason why he must stick to the plan”. The chancellor is “just making it up as he goes along”, Balls added. Perhaps even more cuttingly, Lord Oakeshott of Seagrove Bay (former Liberal Democrat treasury spokesman who worked in Kenya’s ministry of finance and economic planning from 1968 to 1970) remarked that the downgrade was a “self-inflicted injury” for Osborne because he “foolishly erected a triple-A virility symbol” - but “now he’s lost his Viagra”.
Of course, as many commentators have argued, the arcane calibrations deployed by the credit rating agencies bear little relation to any meaningful economic/financial distinctions. Most of the classifications are mainly nonsense, or “largely symbolic” - to use Vince Cable’s words. But what matters is that Osborne has failed his own economic test, quite spectacularly - and there is no avoiding that, however much he may wriggle or squirm.
Some have suggested that the downgrade could be a ‘blame changer’ for the UK’s economic situation, with people potentially switching blame from Labour to the Conservatives. If it comes out in the budget that the growth forecasts and deficit forecasts have gone awry, and if living standards do not rise - then this could become part of a trickle effect over the next few months that leads increasing numbers of people to reject the government’s economic strategy. We might not have to wait that long though - as I write voters are about to go the polls in the Eastleigh by-election.
Many Tory backbenchers are disgruntled, if not getting seditious. Some are openly agitating for Osborne’s removal. Potential replacements being named include foreign secretary William Hague and Philip Hammond, the transport secretary. Adam Afriyie, Tory MP for Windsor - and touted by some Conservative insiders as a future leader - has warned the government that it is entering the “last-chance saloon”: that great cliché we have heard so often during the euro zone crisis. Osborne’s budget next month, Afriyie sternly commented, must deliver real growth by cutting spending and reducing high tax rates in order to kick-start the economy. If not, the government “will not secure a Tory majority in 2015”. Even Boris Johnson’s advisers are calling for a change of course on the economy.
But the fact that George Osborne and the coalition government are in trouble is not automatically good news for the working class. What is bad for them is not necessarily good for us - not by a long chalk. If only life was so simple. The clear message coming from Moody’s, not to mention George Osborne in his own way, is that the world economy is in for an extremely long period of stagnation or perhaps depression.
Meanwhile, the working class gets hammered into the ground - with a triple-dip recession possibly round the corner. During the economic crisis, it has been common to talk about a Japanese-style ‘lost decade’. However, this analogy is misleading. The plain fact of the matter is that we are already in the middle of such a period and there is a long way to go yet - and that is according to the projections of the Office for Budget Responsibility, an institution which has been inclined to bovine optimism (to such an extent that at times you could be forgiven for thinking it was a government propaganda department). The general expectation, easily disappointed of course, is that we will not see any sort of genuine recovery until at least 2020 - at best.
Reflecting the air of desperation about the economy, the deputy governor of the Bank of England, Paul Tucker, is even considering the “extraordinary measure” of imposing negative interest rates to stimulate the economy - meaning, of course, that the lender would pay the borrower for the privilege of lending. But potentially very bad news indeed for savers, needless to say.
Just to make things worse, the euro zone remains mired in recession - seriously impacting upon the UK economy, of course. The European Commission has conceded in its latest forecast that the euro zone economy will shrink by some 0.3% in 2013. Previously, the commission had expected the zone to enjoy 0.1% positive growth this year. But no longer. In 2012 the economy is estimated to have shrunk by a total of 0.6%. Even the supposedly mighty Germany contracted by a relatively sizeable 0.6% - an ominous sign.
Additionally, on top of all that, there is the more than real possibility of an unexpected event (a ‘credit event’, to use the jargon). You do not have to look too far - turn your eyes now to Italy, where the electorate have decisively rejected the technocratic administration of Mario Monti, so loved by the markets, Euro-bureaucracy, Financial Times, etc. Unsurprisingly, the bourgeoisie, the Eurocrats and the markets are beginning to panic - who on earth is going to ‘responsibly’ run the euro zone’s third largest economy?
Far from the euro crisis being solved by the European Central Bank’s promise to buy unlimited quantities of distressed government bonds, the problem has just been building up - becoming potentially catastrophic. If the financial firewalls are not up to the job, then we could have the dreaded scenario of contagion spreading from Italy - which would pose an immediate danger to the entire euro project. And if the euro goes, the entire world system would crash too.