The temptation to believe in the concept of a free lunch is one which has proved irresistible to numerous governments through the ages. Henry VIII, for example, has seized popular imagination once again through the brilliant portrayal of him by Damian Lewis in Wolf Hall. Bluff King Hal is the nickname often associated with the King. But to his subjects, especially towards the end of his reign, he was more usually called Old Coppernose. He debased the silver coinage with so much copper that, when the coins were used, the copper shone through the flimsy cover of silver onto his portrait.
The Office for Budget Responsibility has recently produced an excellent little document which shows how post-war governments in the UK have indulged themselves in the modern equivalent of coinage debasement. The dry title is ‘A brief guide to the UK public finances’, but it contains fascinating material.
Since 1948, British governments have run deficits on the public finances in 54 out of the 66 financial years. In the most recent four decades, surpluses have been registered on only five occasions.
It all started off so well. The post-war Labour government of Clement Attlee was heavily interventionist, nationalising the mines, socialising health care in the NHS. But it was a model of fiscal rectitude. It ran a surplus in every single year until its defeat in 1951, including what is by far the largest post-war surplus in 1948 itself, amounting to nearly 5 per cent of GDP – getting on for £100 billion in today’s terms. The Conservatives carried on in the same way. From 1948 until the election of the next Labour government in 1964, public sector surpluses and deficits more or less cancelled each other out over time.
This is exactly how it was meant to be. Keynesianism, as it was originally conceived, required the government to run deficits when the economy was slowing down, to boost demand, but to offset these by surpluses in the good times. But since 1964, the cumulative size of the annual deficits comes to no less than 160 per cent of GDP. A nice little earner with which to bribe electorates.
Governments have got away with it thanks to inflation. The bonds they issue to finance deficits are denominated in money terms. When they mature, they simply pay back the face value, regardless of what has happened to prices in the meantime. Even with only 3 per cent inflation, prices double in just 23 years. And this doubling halves the real value of debt issued at the time.
The zero inflation world in which we now live changes the rules of the game. Any debt which is sold to finance public sector deficits will have to be repaid for real. Both George Osborne and Ed Balls are smart enough to understand this. The same cannot necessarily be said for many of their senior colleagues. And the biggest task is to convince the electorate, especially in the subsidised areas, that their living standards from now on will depend upon their productivity. No more free lunches.
As published in City Am on 22nd April 2015