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As the U.S. Goes, So Goes Britain

Tags Booms and BustsMonetary TheoryMoney and Banking

11/10/2003Grant M. Nülle

The Mises Institute's October 24–25, 2003 Supporters' Summit dealt with the topics "War, Prosperity and Depression." The title was apt, considering that the United States still suffers from a financial hangover courtesy of a Federal Reserve-induced stock bubble that burst in 2000. At the same time, Americans have been compelled to bankroll the federal government's insatiable appetite for borrowing and spending other people's money.

To the chagrin of adherents of the Austrian School, America has also embarked on military adventures abroad, ostensibly to root out the perpetrators of terrorism and unseat those dastardly governments that would presumably harbor Washington's foes, leaving American soldiers with the daunting and thankless task of nation-building.

Washington has not been alone in pursuing its crusade against terrorism and realizing the fantasies of the Neo-Conservative movement. A muddled-headed internationalist of the center-left persuasion, Britain's Prime Minister, Tony Blair, reaffirmed his country's post-imperial foreign policy role of playing the Greece to America's Rome. In the post 9–11 era, Westminster has backed the U.S.-U.K. "Special Relationship" to the hilt by participating in the invasion and occupation of Iraq as well as Afghanistan.

Far from merely sharing geopolitical preferences, Britain is similar to America in that it is suffering from the same political and economic maladies that have befallen its transatlantic cousin. Indeed, faced with a burgeoning fiscal deficit, fiat money-precipitated economic imbalances and renewed imperialism, albeit at Washington's behest, the U.K.'s own variant of "War, Prosperity and Depression," underscores the sources of America's woes, which were enumerated during the October Supporters' Summit.

Tory Lite

After 18 years out of office, the British Labour Party returned to power in 1997. The assent was abetted in part by tax hikes, macroeconomic mismanagement, and the general stodginess of John Major's Conservative government. Of greater importance to the 1997 general election results was Tony Blair's instrumental role in transforming his party's penchant for blatant economic interventionism into a pragmatic and centrist pandering organization, rebranded "New Labour." 

At the heart of the political makeover was Mr. Blair's highly touted "Third Way," which promised to incorporate the best features of Clement Atlee's 1945 imposition of the welfare state on Britain and Margaret Thatcher's bid to roll back state power.

Moderation was the order of the day in the first New Labour government as Mr. Blair scrapped his party's reputation for exorbitant tax and spend measures, opting to commandeer Tory policies instead. Indeed, the prime minister focused on modifying the British Constitution, participating in NATO's foray in Kosovo and above all refraining from arousing the ire of centrist voters.

Her Majesty's government was aided in this endeavour by robust economic growth, which was largely driven by exports to an American economy at the apex of the boom phase of the trade cycle. Taken together, a prudent political strategy and an economy fueled by monetary easing (see below) on both sides of the Atlantic returned Labour to power following the June 2001 general election with an even larger parliamentary majority.

Unabashed Interventionism

Flush with victory, New Labour jettisoned its interventionist inhibitions and embarked upon a spending spree reminiscent of previous premierships.

Telltale signs of a statist agenda were discernible during Mr. Blair's first term from 1997 to 2001 as the government launched its "New Deal" headlined by the institution of a minimum wage. Britain's Chancellor of the Exchequer, Gordon Brown, deftly assumed the role of social engineer via his Byzantine system of tax exemptions and statutory contribution schemes, which served to further distort incentives and impair the operation of a free market.

In contravention to a 1997 election manifesto pledge that, "New Labour will be wise spenders not big spenders," in 2001 Messrs Blair and Brown proceeded to posit massive sums of tax revenues into the public services. State entities, like the notoriously inefficient National Health Service (NHS), which accounts for a third of Britain's public service spending, received a dollop of cash that year 11 percent greater than the previous one. The government's Office of National Statistics also indicated that total public spending for 2002 was 9 percent higher relative to 2001, the fastest pace since Harold Wilson's profligate Labour government in 1975.

Overall, when one includes the modest increases during Labour's first term into the calculations, national spending on health, education, transport, and the like is 40 percent greater than what it was prior to "New" Labour's ascension to power in 19971.

Mr. Blair's bid to modernize state-provided services by earmarking tax revenues for that purpose has resulted in scant improvements in delivery and satisfaction. Worse yet, Mr. Brown has saddled the country with a burgeoning budget deficit, a mounting sovereign debt and a legion of newly minted bureaucrats.

British government statistics underscore the extent of Whitehall's expansion and the deficiencies of its policies. The volume of government service output from 1997 to present grew by a mere 14 percent compared to the 40 percent increase in spending on the provision of public services. In the span of a year, April 2001–April 2002, over 22,000 new civil servants were added to the government payroll, bringing the cumulative total to over 512,400. The pace of public sector hires exceeds the total increase in British employment by a factor of five2.

"Making the pips squeak"

As the public spending spree has accelerated since 2001, economic growth has slowed as America's appetite for British products has slackened. Concomitantly, activity in Britain's financial services and high technology enterprises, which account for a substantial proportion of the country's slumping industrial exporters, is subdued largely as a result of the puncture of America's stock bubble. Business investment fell by 8 percent in Britain during 2002 and is expected to decline again in 2003.

Although the U.K. posted the highest GDP growth rate among G7 (2.1%) countries and third highest in 2002 (1.7%), the results are well below the Bank of England's (2.5%) and the Treasury's (2.75%) trend rates of growth.

Combining augmented public spending and falling tax revenues—the result of a slowing economy—has proven to be a recipe for a burgeoning budget deficit. Like America, Britain's surpluses of the late 1990's have vanished with the only distinction being the former dipped into the red by throwing money at tax cuts and defence whereas the latter opted for plumping public services.

Her Majesty's Treasury optimistically projects the government's budget deficit to exceed £27 billion or 3% of GDP in fiscal year 2003. Some private sector forecasters reckon the shortfall to increase to near £40 billion per year by fiscal year 2005.

More troubling for the maligned British taxpayer is the budgetary chicanery implicit in Gordon Brown's future spending plans. In his spring budget, the Chancellor announced that government expenditure growth would drop from 4.5% per annum from 2002 to 2005 to 2.8% per annum from 2006 to 2008, allowing public services' budgets to grow by 3.5% per annum in the latter period.

However, as The Economist noted in early October, substantial spending commitments have already been made for the NHS from 2006 to 2008 and the current pace of education spending (6% year) is unlikely to be curbed, portending an abrupt freeze in all other departments' funding growth if Mr. Brown's budget projections are to be met. If one knows anything about politics, capping spending on transportation, defense (especially amid America's war on terrorism) and other services is simply unfeasible3.

Britons confront the unsavory prospect of tax hikes, better known as "making the pips squeak," and swelling budget deficits in the near term and possibly beyond, provided a Conservative Party beset by leadership and identity crises cannot mount a credible opposition. Even if the Tories could surmount their self-inflicted difficulties, their position on public spending differs little from Labour.

Enter the Bank of England

Abysmal interest rates, if not commensurate with the unhampered market's time-preferences, stoke present consumption and foster excessive debt. The hallmarks of a boom phase are evident in Britain, care of the Bank of England.

Unanticipated by almost all observers, with the exception of Alan Greenspan whose counsel and consent was sought by the Treasury beforehand, New Labour's initial act in office in 1997 was to enable the Bank of England to determine interest rates independent of the Chancellor of the Exchequer. The act reversed Old Labour's, if there really is a distinction, nationalization of the bank in 1946.

Apart from an increase of the repo rate from 6% in 1997 to 7.5% in 1998 and another brief increase at the zenith of the 1990's transatlantic boom, interest rates in the United Kingdom have fallen largely in tandem with the United States. Currently, Britain's repo rate stands at 3.5%, the lowest since 1955; the American equivalent is 1%.

The latest edition of the Bank of England's Financial Stability Review4 serves as a textbook example of some of the features of the Austrian Theory of the Trade Cycle. If one is able to wade through the banking jargon-laden report, it becomes evident that Britain's corporate sector, which has seen profitability and investment figures decline since America stock bubble burst, is being propped up by artificially low interest rates.

To be fair, rationalization has occurred within Britain's corporate sector—its aggregate financial balance has swung from a deficit of 3% of GDP in 1999 to a surplus of 1.4% of GDP as of late 2002. However, the contraction of businesses and rectification of malinvestments that one would expect to occur in the bust phase of the trade cycle have been forestalled by the Bank of England's monetary easing.

Since 2001, Britain's repo rate has fallen from 6% to 3.5%, notwithstanding a lull in rate reductions during most of 2002 signalling a nascent revival in the corporate sector's fortunes are beginning to appear, fueled by mean borrowing costs.

Binge Borrowing

As for Britain's households, debts are being amassed at a record clip. On October 29th, the Bank of England announced that consumer borrowing in September 2003 topped the previous all-time record. Britons tacked on £10.7 billion of debt that month, up 14% since September 2002. Mortgage lending led the charge, increasing by £8.8 billion in September, another record5. To complete the triumvirate of astounding borrowing figures, 136,000 mortgages were approved in September, a level not posted since the halcyon days (as far as boom enthusiasts are concerned) of 1999.

The flurry of consumer activity has been most resilient in Britain's housing markets. Nationwide, the country's largest construction society, reported that in October annualized house price growth averaged 16.1% from the previous year. October's clip scarcely dims in comparison from the annualized rate recorded in May 2003, when Nationwide reported the figure as 17.9%.

Not since the late 1980s, when Britain last suffered from a housing price bubble and its subsequent puncture a couple years later, has the cost of acquiring a home risen so quickly.

Meanwhile, unsecured lending, particularly in credit cards, continues to grow by over 10% at an annualized rate.

To be sure, the unfounded optimism and lax mentality attendant amid an artificially cheap credit marketplace fosters additional transgressions and excesses. A program televised by the British Broadcasting Company on 29 October revealed advisors, bankers and brokers of some of the country's largest financial institutions had exhorted buyers to record incomes higher than they really earned on applications to secure larger loans. Lenders have also eased rules permitting borrowers to take out loans on houses amounting to 2.9 times greater than their annual income, up from the typical 2.66.

Boom Endgame?

The most important factor in explaining the relentless consumer borrowing remains the Bank of England's interest rate tinkering. Growing increasingly concerned, albeit at the eleventh hour, about the unmitigated accumulation of household debts, Bank of England Governor Mervyn King and the Monetary Policy Committee are expected to raise interest rates by a quarter point when it meets on 6 November, the first such rate rise since the early months of 2000.

The chairman of Britain's Financial Services Consumer Panel, Ann Foster, has portended the lean times ahead for British households resulting from climbing interest rates. She recently said, "I have a horrible feeling that some people are in for a nasty shock, particularly those who took out mortgages in low-interest rate times. Some people have been borrowing to the limits because of high house prices."

But without self-inflicted financial fires to extinguish, where would central bankers find employment?

As for Her Majesty's government, it may want to take heed of the Conservative Party's travails amid the housing boom and bust of the late 1980s and early 1990s, which undermined the British middle class's confidence in the Tories' economic policymaking competency. History may repeat itself for New Labour in the twenty-first century, with Tony Blair being ignominiously remembered as George W. Bush's articulate patsy and as another Labour "tax and spend" prime minister.

In this latest episode of "War, Prosperity and Depression," the best Britons can do is brace themselves for the impending contraction of economic activity and proliferation of corporate and household financial restructuring, including bankruptcy, which are requisite to remove the distortions incurred during the credit-induced boom. In short, they, like their American cousins, would be wise to clench their pocketbooks tightly.


Contact Grant M. Nülle

Grant Nülle, MBA, is a former legislative staffer, finance director, and budget analyst with extensive experience in fiscal and economic policy. He is currently working on a PhD in mineral and energy economics in Colorado.

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