A blunt warning from Britain

Somewhat obscured by the UK election results drama last week, the Governor of the Bank of England, Mervyn King gave an extraordinary press conference on Wednesday, May 12. It seems to have received minimal media coverage, given the weight of what King had to say.

Normally the Bank of England talks in bland ‘bank-speak riddles’. At this conference the style of delivery might have been bland but the message and text was punchy and blunt. King won’t have pleased the economically up-beat spin merchants residing in the White House and other national capitals for example. But hopefully they’ll listen, take note and governments will act.

Kings own words say it all. He says an economic recovery is underway but:

“… the financial crisis is far from over. As debt has moved from the financial to the public sector, the banking crisis has turned into a potential sovereign debt crisis.”

“America, and many other large economies including the UK, share some of the same problems as Greece with its public finances:”

“It is absolutely vital, absolutely vital, for governments to get on top of this problem. We cannot afford to allow concerns about sovereign debt to spread into a wider crisis dealing with sovereign debt. Dealing with a banking crisis was bad enough. This would be worse.”

(I’ve provided links to the governor’s statement and the Bank of England web and pod casts on my own site.)

This official ‘outing’ of the possibility of a sovereign debt calamity puts any debate about government debt to rest. It’s the major problem! King’s statements focuses the global backdrop for the political battle in Australia, given Abbott’s declarations that taxes and debt are the issues on which he will campaign.

Australia is lucky to have a comparatively low government debt to GDP ratio. But the federal budget allows that to increase significantly over the next two years. And, there lies our problem. We’re going to have to fund expanding domestic government debt in a global financial environment where government debt risks becoming toxic. At least that’s the legitimate take from King’s comments.

The alternative is that the European Union, the US, Japan and the UK genuinely, and substantially, pull back on their spending so the government toxic debt risk can be tackled. But spending reductions in the world’s biggest economies will surely constrain a global economic recovery.

For politicians this is a scary dilemma. They risk unpopularity whichever way they go. The usual response is to engage in political spin, hoping to fool most of the people most of the time while doing nothing on the chance the problem will fix itself.

The Bank of England (politely) infers this is foolish. King says the problems and contagion of Greece would have been substantially less if tackled much earlier.

Sovereign risk is born from political risk as Simon Johnson, a former chief economist at the International Monetary Fund, detailed in a sobering analysis his experiences in bailing out developing economies in Asia, Eastern Europe and Latin America over the last three decades.

According to Johnson, debt and economic structural resolution is not achieved until the politics changes enabling underlying economic problems to be addressed.

This is as much a lesson for Australia as it is for the big debtor nations.

Ken Phillips is Executive Director Independent Contractors Australia www.contractworld.com.au. He most recently contributed to What If www.connorcourt.com

Full article on BusinessSpectator, HERE
Ken Phillips, BusinessSpectator
Mervyn King