Are Britain and America turning Japanese?

Robert Peston
Economics editor

image copyrightReuters
image captionStocks around the world have fallen on continued fears about a global economic slowdown

The most worrying trend on markets in the past 24 hours has not been the collapse in share prices, but it has been the rise in the price of assets perceived by investors to be less risky: the sharp increase in the price of gold and in the prices of US, UK and German government bonds.

That's wonderful news if you happen to be stuffed to the gunnels with gold, gilts (UK government bonds) and treasuries (US government debt).

But for most of us, this isn't good news. When investors won't take risks, it is very hard for the economy to grow.

Here's the transmission mechanism between risk-aversion and recession.

As bond prices rise, the implicit cost of borrowing falls for the borrower that issues the bond.

So for the US government, according to Bank of England data, the price of borrowing for ten years is now at its lowest level for two centuries - and for the British government, the implicit interest rate it has to pay to borrow is lower than it has been since the end of the Victorian era.

Given how much debt is bearing down on the British and American governments, and the intractable nature of the country's respective deficits (the gap between what they spend and the revenue they take in from taxes), you would think the reduction in their costs to borrow would be a good thing.

And in one narrow sense, of course, it is.

Far better to be like the US and UK, trusted by investors and creditors, than to be like Italy and Spain, where government borrowing costs soared to levels that were almost unaffordable - and have only been staunched by the huge purchases of Spanish and Italian debt made in the past ten business days by the European Central Bank.

Just to remind you, the European Central Bank has itself said that there is a limit to how much it is prepared to in effect lend to Spain and Italy - that its exceptional purchases of their respective debts is not a permanent solution.

So although in that respect it is good to be Britain and America, the torrent of money going into putatively safe US and British government debt is redolent of a worrying trend - whose consequences for all of us could be seriously bad.

Japanese disease

As I have mentioned, it shows that the world's biggest investors and creditors do not want to take risks.

So when money is flooding into US Treasury bonds and British gilts, it means one of two things: either money tends to become harder to obtain by those in the private sector who take the risks which generate economic growth and wealth; or the climate of pervasive anxiety means that even when money is available to consumers and businesses, they don't want to spend or invest it.

Both trends are consistent with what has become known as the Japanese disease - the two-decade phenomenon in Japan of incredibly low growth caused initially by a mountain of debt bearing down on banks and property companies, and then by an entrenched and unbreakable propensity to hoard by all important economic players.

The UK and US haven't become Japanese yet - although, as you know, the recovery in most of the developed West since the Great Recession of 2008-9 has been far shallower and weaker than recoveries from other post-war recessions.

Which is why the question of what to do to stimulate growth is such an important one.

Right now, the painful corollary of the alacrity with which creditors want to lend the US, UK and Germany is that they don't want to lend to the big banks of Southern Europe - where, as the US investment bank Morgan Stanley has pointed out, all the conditions are in place for a painful credit crunch.

Because international banks are so interconnected, big banks throughout the developed West would find it harder to borrower if a severe funding crisis ultimately afflicted the banks of Spain and Italy.

As you'll have heard me say for years in the manner of a robot whose speech programme has been corrupted and can say only one thing, when banks can't borrow, they can't lend.

You will have spotted the paradox in all of this. Because when the private sector won't spend and invest, surely the thing to do is for the public sector to spend and invest.

Doesn't that mean that the governments of the UK and US should take advantage of the fact that investors want to lend to them so cheaply, and should therefore borrow colossal amounts of new money to finance tax cuts or spending on new roads, railways, hospitals and schools?

That would be the traditional so-called Keynesian remedy: the public sector would be generating jobs and economic activity, to compensate for the failure of the private sector to do so.

Many, including the Chancellor, George Osborne, would say that the traditional Keynesian remedy is not available.

They and he would argue that the only reason the UK can borrow so cheaply is because of the steep cuts in public spending and sharp increases in taxes, designed to close the gap between what the UK government spends and what tax revenues bring in.

Low growth forecast

Mr Osborne would say that if investors became concerned that his commitment was wavering in his battle to cut a deficit equivalent to 10% of GDP since the Great Recession - and perceived by investors to be unsustainably huge - then Britain would be herded into the club of countries whose borrowing costs approach dangerous levels.

"Do you really want to be like Italy and Spain?" he would say. "Because if that's what you want..."

So does that mean that he is powerless to do more to significantly improve the growth prospects of the UK in the next year or two?

image copyrightReuters
image captionThe price of gold has hit a new record high of $1,833.81 an ounce

Are investors condemning the UK and US to years of Japanese low growth?

Well, first of all we have to be careful not to paint the US and UK as being in worse economic shape than they actually are.

Investors may be behaving as though a return to recession is almost a sure thing. What the data shows right now is a slowdown in growth, not a contraction of the economy.

But what if the worst happens? Is there nothing that the UK authorities can do?

Well there is an extreme remedy, which policy-makers have muttered about to me.

I should say at this point - because it is the sort of remedy which will upset lots of people - that I am not saying this will happen.

But you probably need to know what theoretical treatments are left in the armoury if the patient - the British economy - were to go on the critical list.

The Bank of England could engage in an extreme form of quantitative easing.

It could purchase a sizeable amount of British government debt and then announce that the debt was being cancelled, that it never needed to be repaid.

It would therefore be dropping cash into the economy, it would be pure helicopter money, to use the phrase beloved of economists.

And if those who received the money didn't want to spend it, if they hoarded it, the government could in those circumstances cut taxes or increase public spending to stimulate demand - because the consequential increase in the government's deficit would not be leading to any increase in the national debt (remember that in this hypothetical case, the Bank of England has told the government it never needs to repay a big chunk of what it owes).

Now you probably don't need to be told that creating money in this way would be fraught with risks. Confidence in the value of the currency and in the credit-worthiness of the British government might collapse.

It might in a micro-second take the UK from deflationary low growth into conditions of hyper-inflation and soaring interest rates.

So extreme QE may best be seen as the anxious musing of British officials, who fear that the UK economy is in a Doris Day phase ("que sera sera, whatever will be, will be") and that the best hope for the over-indebted West would be a pact with the financially stronger, surplus countries such as China and Germany that they'll stimulate their domestic consumption and buy more of what we produce (I wrote about this remedy recently).