Can Britain really afford ‘whatever it takes’?
Markets are now starting to question the UK’S ability to pay, and the Bank can only partly quell the flames
Boris Johnson and his Chancellor, Rishi Sunak, promise to do “whatever it takes” to defeat the Covid-19 pandemic. The question being asked in markets is not of their intent, but whether they can afford it. Can an economy already weakened by worries about its impending divorce from Europe withstand the vast costs of the actions now deemed necessary to bring the virus under control?
Like the illness itself, markets have been disproportionately attacking those thought to have the most acute underlying conditions – in this case economic rather than medical. For the UK, the most glaring manifestation is not so much stock markets – which have fallen roughly in line with everywhere else – as the pound, which is down to some of its lowest levels since the mid-1980s, when it briefly traded at near parity to the dollar. The yield on 10-year UK Government debt (gilts) has also approximately doubled over the past few days, albeit from an exceptionally low level.
There are lots of technical explanations for these moves, which, it might therefore be argued, are of little long-term significance. It should also be noted that markets are often wrong, and in a panic invariably overshoot the fundamentals before recovering somewhat.
Nonetheless, they reflect genuine concern about the economic costs of the lockdown now being imposed to flatten the curve of the virus’s progress. These costs are going to be considerable, not just to business, but to the public finances still struggling to recover from the financial crisis of a decade ago. When the economy is force-stopped like this, the Government becomes the insurer of last resort, underwriting wages and lost revenues. The solvency of the state itself is then questioned.
The reawakening of deficit spending will require massive bond issuance at a time when almost all governments are looking to tap debt markets to prop up distressed economies. There is a resulting scramble for investors’ money, when all investors really want is cash, not sovereign paper.
Countries such as Britain, with sizeable current account (or trade) deficits to finance, must rely on foreign investors to balance the books – what Mark Carney called “the kindness of strangers”. Unfortunately, capital markets are not kind; they are amoral, clinical, ruthless and Darwinian in their judgments, and right now their verdict on the UK is not at all good.
To counteract these negatives, the Bank of England is cranking up the printing press anew, with an additional £200 billion of “quantitative easing” and another emergency rate cut – fire fighting that only partially quells the flames. The idea that countries with their own currencies can’t go bust because they can print the money to pay their debts is only partially true. Markets will take it out on the currency, causing inflation to take off if they suspect this kind of debt monetisation, with the central bank directly financing the deficit, is going on.
I have got myself into trouble on social media for making a variation of the following point, so I must choose my words carefully. We are already at a point where the immediate and, no doubt, lasting economic costs of Covid-19 are out of all proportion to the distress of the disease itself. In attempting to combat the virus, as all civilised societies must, we are doing ourselves untold economic damage. This matters if it impairs our ability to weather similar threats – economic, epidemiological or military – or indeed if it saddles future generations with an intolerable debt burden.
We will eventually come through this, and probably rather sooner than some of the more doom-laden projections suggest. We must in any case hope so, because financial markets are entirely right in questioning how long the economy can withstand today’s nuclear winter.
Just as the financial crisis highlighted a state of reckless disrepair in the banking system, this one is showcasing something similar in healthcare provision. Prior to the credit crunch, banks had run down their capital buffers to wafer thin levels, boosting returns and bonuses accordingly. When the storm came, they were found to be woefully inadequate, with many banks quickly becoming insolvent.
In the name of economy, we have similarly allowed our healthcare system to function at a dangerously exposed level of “just-in-time” full capacity, leaving nothing spare for a pandemic such as this. In much the same way as the banking system was almost criminally short of capital, the NHS lacks the staff, beds, intensive care units and even testing kits to cope.
One defence of the NHS is that we get plenty of bangs for our bucks, an adequate universal healthcare system at limited cost compared with many other advanced nations. This is now proving to be a false economy; in an attempt to stop the NHS being overwhelmed, we are being forced to take a gigantic economic hit.
If there is a positive to come out of all this, it is the realisation that we need to spend a much higher proportion of our national income on healthcare. How we manage this is a subject for another column, but we have just received a massive wake-up call as to the economic dangers of skimping on medical provision.