A Tale of Two Borrowers
Treasury officials are saying that a record UK deficit for August is further evidence that the coalition is right to press ahead with cuts. But they might be on stronger ground pointing to this morning's sovereign debt auction in Ireland.
Today's figures show that the government borrowed £15.9bn last month - the highest August deficit on record. Net debt, relative to GDP, rose to 56.3%. That borrowing figure was about £3bn more than City economists expected, and had some worrying that the Treasury would miss its borrowing targets for this year.
Of course, it is far too early in the fiscal year to draw that kind of conclusion. In fact, before this month, the borrowing figures had come in below expectations in nine of the previous 12 months, with revenues coming in surprisingly strong. These numbers don't change that basic picture - revenues always tend to be weak in August, and so far they are still 9% up on last year, compared to a Treasury forecast of 6.6% growth in 2010-11. If nothing changes, total borrowing this year would still come in several billion below forecast.
The disappointment in August was on the spending side - and entirely accounted for by the fact that a year ago the retail price index (RPI) was negative, and interest spending was freakishly low. (To see how freakish: the Treasury paid out just £1.3bn in debt interest last August, in a year in which the total cost of servicing our debt rose to £32.3bn).
Nick Clegg made much of the rising cost of debt interest in his speech yesterday: "Already we are spending £44bn a year on interest alone. Under Labour's plans, that would have risen to nearly £70bn. A criminal waste of money that shouldn't be lining the pockets of bond traders. It should be paying for police, care workers, hospitals and schools."
It's a strong line of rhetoric - which Labour politicians like Ed Balls will recognise from their time in opposition in the 1990s. He used to say the same thing about Conservative borrowing.
It's worth pointing out that debt interest costs will not be far off £70bn under the coalition's plans either, increasing to £66.5bn in 2015-16. Under Labour's plans, the Office for Budget Responsibility (OBR) reckons it would have reached this level just one year earlier, in 2014-15. That is a lot of money: for reference, total public-sector net investment this year will be just £39bn.
But Mr Clegg said that the last government's borrowing had taken the country "to the brink of bankruptcy". That is similar to rhetoric that Chancellor Osborne has used - but it is simply not true.
As it happens, governments can't go bankrupt - they can only default on their debt. But I'm not just being pedantic. The facts are that on the eve of the election, the UK still had an uncontested triple-AAA credit rating, and the market was demanding an interest rate of just 3.9% to lend the government money, compared to 3.7% for US bonds and 3.1% for Germany. (That UK rate might have been higher had investors not been expecting a Tory victory, but the average yield for the previous 12 months was about the same.) Whatever you think about the fiscal mess that the coalition inherited, these are not the characteristics of a country on the "brink" of bankruptcy or default.
No, if you want to get a sense of what that feels like, you have to go to Athens. Or, perhaps, to Dublin, where the government was relieved to raise 1.5bn euros in the sovereign debt markets this morning, but had to pay an implied interest rate on the longer-term debt of just over 6%. In June the yield on a similar bond was 5%.
The growing suspicion in the markets is that sooner or later, Ireland will become the second country to borrow from the new European Financial Stability Facility. That's not the same as admitting bankruptcy. But in today's eurozone, it's the closest that governments will get to admitting they can't cover their debts.
Ministers in Dublin swear this will not happen, and they do have some protection against market storms in the next few months: they have pretty much issued all the new debt the government needs for this year, and they have relatively little existing debt coming up for maturity. In addition, Credit Suisse reckons the government has about 20bn euros in cash reserves squirrelled away which could well come in handy.
But the risk of a full-blown loss of confidence is clearly there, in a country where nominal gross domestic product (GDP) has fallen about 20% since the crisis began and government debt has risen by 60% of GDP.
What's fascinating about the Irish situation is that it has rather little to do with the size of the deficit - or a government failure to take tough action. In fact, as I have written in the past, Ireland was the first country in Europe to announce massive spending cuts and tax rises.
What's worrying investors now isn't the deficit in itself but the huge debts sitting in the financial sector - and how many of them the government will ultimately be forced to honour. At the last count, the government's "contingent liability" in the banking system - the stock of debts that it has guaranteed stood at 153bn euros - nearly 95% of Irish GDP.
So if you're a Liberal Democrat activist who wonders whether Britain really needs to get a handle on its debt - Ireland is indeed a great cautionary tale. The government has lost control of its balance sheet, and in the process lost a great deal of its national autonomy. That might have happened to the UK if we had continued to borrow more than 10% of GDP a year. But Ireland is also a reminder that bringing down public borrowing is only part of the problem - government has to worry about what's going on the private sector as well.