Comment

Sunak can only cut debt by punishing savers

A stealth taxes on domestic savers and gilt holders is the least politically-troubled route out of the Covid-19 mess

Rishi Sunak
Lifting the debt burden will be tough for the Chancellor

In ancient Rome, a general entering the city in triumph after campaigns on behalf of the empire would always carry a slave in his chariot. The slave's job was to whisper over and over the words "memento mori" in the commander's ear as he lapped up the adulation of the crowds: remember, you are mortal.   

Robert Chote, the outgoing chairman of the Office for Budget Responsibility, is far more independently minded than a Roman slave. But he will offer his own memento mori to the Chancellor, Rishi Sunak, today in the watchdog’s latest – and likely damning – assessment of the risks posed by the pandemic to the Government's own fiscal sustainability.

Sunak is by far the most popular member of  a Cabinet decidedly tepid in talent and has rightly won plaudits for his handling of Covid-19 as he deploys vast fiscal firepower. But in fulfilling his pledge in the summer statement that "we must, and we will, put our public finances back on a sustainable footing" he will quickly find that there are no good options. Already the Chancellor looks a prisoner of a debt pile surging towards 100pc of GDP. 

Even before the pandemic, the OBR had tough words to say about Theresa May’s health spending spree in 2018. This, on top of the extra pressures brought about by an ageing population requiring extra health spending, threatened to push the UK’s debt to GDP ratio to a mammoth 282pc by 2068 if left unaddressed. So how exactly does Sunak deal with the newly-swollen debt to achieve that sustainability he covets? 

Let's consider some options: first, growth. Immediately after World War II, the UK’s debt to GDP ratio stood at more than 200pc. But as rebuilding began, the country embarked on a 30-year run of sustained economic growth, virtually full employment and rising incomes until the Bretton Woods consensus broke down in the 1970s. That, along with a bit of inflation, lowered debts as a share of the economy. 

This time around things are different. There is no wartime destruction to rebuild and the contribution of the baby boomers at the other end of their lives is a fiscal handbrake, as the population ages. The UK’s productivity issues are the economy's chief running sore since the global financial crisis and other structural factors such as Brexit potentially weigh on labour supply.

Hence the Bank of England thinks the UK's trend growth rate, effectively the economic "speed limit", is now around 1.1pc a year, less than half that of a decade or so ago. Covid-19 will raise unemployment and kill off companies as well, so the situation is unlikely to improve.

Inflating the debt away also seems tricky as central bankers around the world have been desperately hunting for some inflation, anywhere, for years. Despite a surge in the money supply to fight the pandemic, advanced economies are fighting secular trends like population ageing and a glut of savings pushing down on equilibrium interest rates.

Even if such an approach was feasible through some dramatic tearing down of the monetary framework – for example, a move to overt monetary financing and ending Bank of England independence – then the genie would be well and truly out of the bottle.

At a point when the UK is selling more than £400bn in gilts a year, and rolling over existing borrowings, it seems outlandish not to expect the bond markets to exact a premium punishing enough to turn an economic catastrophe into a full-scale meltdown. Lest we forget, higher inflation also puts up the Government's spending costs, as well as chipping away at its debts.

That brings us to austerity. A wide-ranging study by three Italian economists, Alberto Alesina, Carlo Favero, and Francesco Giavazzi, put Keynesian types on the back foot last year with their research of austerity programmes in 16 countries. Their book concluded that spending cuts were far less damaging than tax rises and not necessarily damaging at the ballot box either; witness Labour's defeat in 2015.

But in Boris Johnson we have a prime minister who doesn't even utter the word. The PM's love of a grand projet, from cable-cars and (aborted) garden bridges to airports and even bridges to Ireland, is one of his defining characteristics.

In any case the likely post-Covid unemployment crisis will need jobs – indeed entire new industries – to be created. The private sector should lead, but the public sector will have to pump-prime the investment. 

After Covid-19 and a brush with his own mortality, forcing through public sector pay squeezes would also be political suicide for the PM. Remember Theresa May lecturing nurses that "there's no magic money tree" in 2017, and beware. The ending of the triple lock on pensions seems a more probable route, but again comes with political costs.

Let's also rule out the cancellation of the £735bn in bonds bought by the Bank of England over 11 years of quantitative easing. Tempting though it may be, the Bank's chief economist Andy Haldane told the Telegraph in May the "optics of that are absolutely horrific", adding: "I don't think bankrupting your central bank and having to recapitalise it is a good look right now." Quite.

That leaves the last option: financial repression. More overt methods such as capital controls are off the table now Jeremy Corbyn's leadership is fading into history, but the likelihood is that domestic savers will be "under-paid" for years to come.

Besides the Bank of England's QE programme, since the financial crisis our banks have been effectively forced to hold bigger stocks of highly liquid assets like sovereign debt, again pushing the Government's interest rate down. Don't forget the insurers who also have to buy safe assets like gilts to fill pension deficits.

Against the rock bottom rates produced, even low inflation would help ease the debt pile. All the more so if the Bank of England follows the example of its Japanese counterpart and adopts yield curve control, buying bonds to lower interest rates at the far end of the borrowing curve. 

It promises to be a long, slow grind which will make savers poorer as a result, but politically, it is the least worst option. Meanwhile the Government will have to pray that interest rates remain low, as the OBR will offer a stark reminder of what could happen if they don't. Against these brutal debt dynamics, even an all-conquering Sunak is going to struggle.