Global Economic Crisis

The British economy, still struggling from the aftereffects of the 2008 Global Economic Crisis and financial disaster, now has received another boot  in its ribcage. Moody’s, one of the three major credit rating agencies, has cut its assessment of the UK’s sovereign debt form AAA to  Aa1.

The U.K.’s Chancellor of the Exchequer, George Osborne,  put a brave face on Moody’s slap in the face of the political managers of the British economy, by telling the media that the credit agency’s downgrade of the nation’s credit rating was “a stark reminder of the debt problems facing our country. Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it. We will go on delivering the plan that has cut the deficit by a quarter.”

Typical of other policymakers in the advanced economies gripped by a proverbial sovereign debt and economic crisis, Osborne engages in meaningless platitudes and cliches, hoping to restore market confidence shaken by a credit downgrade through the sophistry of political rhetoric. However, a politician’s words cannot on their own transform structural fiscal and economic realities that are driving the global economic crisis and its parallel sovereign debt crisis.

Cutting the deficit by a small portion through austerity measures that have thrown the British economy back into recession, which means the economic growth that is essential for the future servicing of the U.K.s massive sovereign debt, is looking increasingly more forlorn a hope, appears to be a dysfunctional remedy at best. In addition, Moody’s rating cut may impose upward pressure on gilt yields, leading to even higher future budgetary deficits. And, with a new Governor soon to take over as head of the Bank of England, it is not certain that the embattled and befuddled British politicians can rely on the nation’s central bank to again become the lender of last resort through the money printing engendered through quantitative easing.

Moody’s has done more than just kill the U.K.’s AAA credit rating; it is a reminder of how dire the economic and fiscal situation is in Britain, just as it is in the Eurozone, U.S. and Japan.

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For the first time in about 40 years, the UK has gone into a double dip recession. London’s Office for National Statistics reported a 0.2 percent contraction in GDP in Q1 of 2012. That drop, following a 0.3 percent fall in Q4, represents two consecutive months of economic contraction, meeting the technical definition of an economic recession.

The UK’s Chancellor of the Exchequer, George Osborne, said, “It’s a very tough economic situation. It’s taking longer than anyone hoped to recover from the biggest debt crisis of our lifetime… over many years this country built up massive debts, which we are having to pay off.”

That sums of the UK’s economic and fiscal conundrum, and that of other advanced economies. The austerity measures required to trim back government deficits represent a fiscal drag on the economy. That in turn retards economic growth and reduces government revenues, countering the intended goal of the austerity measures. On the other hand, maintaining high deficit spending is unsustainable. The politicians have created problem that defies solution.

The Conservative/Liberal Coalition now running the government in the United Kingdom began its administration with a flurry of draconian spending cuts. Under the leadership of Prime Minister David Cameron and its chancellor of the exchequer George Osborne, this imposed austerity has been unleashed under the threat of a looming sovereign debt crisis. Social spending is being radically reduced, and the armed forces, especially the Royal Navy, are being virtually disarmed. The question therefore must be posed; will these austerity measures succeed in their stated purpose, which is removing the danger of a sovereign debt catastrophe in the UK?

There are disturbing indications beginning to accumulate that point to the steps being undertaken by Cameron and Osborne as being too late and insufficient. The UK’s Office for National Statistics has just released public spending figures for November, and they show that net public borrowing requirements increased to a record  £22.770 billion. This staggering level of deficit spending seems to show that the UK is now in a public debt trap. Even though unlike the U.S. most of its public debt is long-term, the British government has accumulated a national debt so large that even small increases in bond yields will add significantly to the need for more public borrowing, making it unlikely that even Osborne’s austerity budget will have much impact. Furthermore, these same austerity measures risk a double-dip recession in the UK, further depressing government income. All these trends point to an elevated danger of a sovereign debt implosion confronting the United Kingdom, in a timeframe that may be much sooner than many analysts would anticipate.

As expected, George Osborne, Chancellor of the Exchequer in the new British coalition government, unveiled an emergency budget aimed at tacking the UK’s massive structural fiscal deficit. It is being described as the toughest UK budget since the age of austerity that followed in the immediate postwar period after the Second World War. It features a rise in the VAT to 20%, increased income and capital gains taxes, public service wage freezes and across the board programmatic budget cuts. The question that stands is this: will it work?

In my view, as explained in my book (Global Economic Forecast 2010-2015: Recession Into Depression) the United Kingdom, as with many other advanced economies, is in a fiscal and demographic trap. It’s national debt has skyrocketed to almost 70% of GDP; even with the Osborne budget cuts, continuing deficits will send this ratio towards 100% of GDP in the near future. With an aging population, meagre real economic growth at best and an economy that, like a heroin addict, has become dependent on its fiscal deficit fix, the UK economy is in such a trap.

Cut public spending dramatically, warn the critics, and the British economy will enter a double dip recession, and they are right. A renewed economic contraction will diminish tax revenue, largely defeating the purpose  of budget cuts and increased levels of taxation. However, continuing the neo-Keynesian debt folly is even more calamitous, for it will inevitably lead to a total fiscal collapse of the UK.

The real lesson is that the wild spending spree engaged in by policymakers in response to the global economic and financial crisis was flawed, and should have been curtailed before public debt to GDP ratios exploded to unsustainable levels. It is now too late to avoid severe economic pain. The only option left is determining which path will incur the least suffering on society.