Cameron's Austerity Sets Benchmark for G-20 Summit
U.K. Prime Minister David Cameron is showing the way on fiscal austerity as he attends his first summit of world leaders today. Whether his path leads to recovery or another recession is driving a transatlantic dispute that will dominate the talks in Canada.
Chastened by the Greek crisis, Cameron’s six-week-old government this week proposed Britain’s biggest round of budget cuts since World War II to reduce a deficit worth 11 percent of gross domestic product, the largest in the Group of 20.
European policy makers fear failure to patch up public finances now risks reviving a bond market selloff that required a bailout for Greece last month, while President Barack Obama says deficit reduction could hurt economic growth and employment. The U.K. presents a test case for G-20 politicians as they argue how quickly to act.
“This is going to be one of the biggest experiments, and the U.S. can sit and watch and look to see what happens to the U.K. output data, which I suspect is about to collapse,” David Blanchflower, a former Bank of England policy maker, said in a radio interview with Tom Keene on “Bloomberg Surveillance.”
Cameron, Obama and colleagues from the Group of Eight meet today in Huntsville, Ontario, and join their G-20 counterparts tomorrow in Toronto. Leaders last year anointed the enlarged group as the main forum for global economic coordination.
Just as they split on how much to spend fighting the global credit crisis, governments are now at odds over when to start trimming a G-20 debt load that the International Monetary Fund estimates will average 110 percent of GDP in 2015.
While China’s decision to allow a more flexible yuan may cool discussions over exchange rates, divisions also exist over what buffers banks should introduce to avoid future crises and how to force them to cover the cost of a potential rescue.
“Consensus among the G-20 has been the hallmark of prior summits and the source of its effectiveness,” said Daniel Price, who organized the November 2008 G-20 summit for former President George W. Bush. “That consensus may be fragmenting.”
Chancellor of the Exchequer, George Osborne, began June 22 with an emergency budget that imposed a levy on banks, raised the sales tax and slashed spending. The plan, alongside measures proposed by the prior government, will generate 113 billion pounds ($169 billion) of deficit cuts, 15 percent of the 737 billion-pound budget foreseen for 2015, the Treasury said.
Cameron’s plan this week won the endorsement of bond investors and credit rating companies. Fitch Ratings said the “ambitious” budget ensured Britain would keep its AAA credit rating, while Moody’s Investors Service said the U.K.’s budget is “supportive” of the top credit level.
U.K. gilts headed for the biggest weekly gain in a month today. The 10-year gilt yield was little changed at 3.40 percent, leaving it 15 basis points lower from June 18. The 4.75 percent security maturing in March 2020 fell 0.07, or 70 pence per 1,000-pound ($1,499) face amount, to 111.08. The two-year yield was at 0.74 percent.
The pound appreciated 0.2 percent to $1.4960 at 3:32 p.m. in London and depreciated 0.2 percent to 133.52 yen from 133.84 yen. It was 0.4 percent stronger against the euro at 82.22 pence.
Deputy Prime Minister Nick Clegg said the U.K. could have been the next victim of a “market panic” sweeping Europe if the government had not acted. Such concerns may have driven up local borrowing costs for companies such as Tesco Plc, the U.K.’s biggest retailer, and GlaxoSmithKline Plc.
Osborne’s Labour predecessor, Alistair Darling, yesterday told a Bloomberg Link conference in London that if you “take all this money out of the economy” its recovery may stumble. Osborne dismisses the view that nations can’t reduce deficits and support growth in lockstep as presenting a “false choice.”
“The crisis in the euro-zone shows that unless we deal with our debts there will be no growth,” he said. “A credible plan to cut our budget deficit goes hand in hand with a steady and sustained recovery.”
“The assertion that fiscal tightening reduces growth is far from proven,” said Ben Broadbent, an economist at Goldman Sachs Group Inc. in London, who says budget cuts can be offset by looser monetary conditions such as a falling exchange rate. He predicts the U.K. will expand 3.1 percent next year compared with the 2.3 percent forecast of the Office for Budget Responsibility.
Cameron’s call for prudence is echoed elsewhere in Europe six weeks after the region’s governments united to save Greece from default. German Chancellor Angela Merkel, whose Cabinet this month backed budget cuts worth more than 80 billion euros through 2014, said June 22 that she told Obama reducing debt is “absolutely necessary.”
Countries including Greece and Spain are already introducing austerity plans, and outside Europe, Japanese Prime Minister Naoto Kan this week pledged to cap spending for three years and overhaul the tax system.
The recent experience of countries from Canada to Ireland proves it is possible to slash budgets and maintain economic growth, according to Andrew Lilico, chief economist at the Policy Exchange, a London-based research group.
That’s not stopping Obama from warning against a premature retraction of stimulus given unemployment remains near 10 percent and synchronized cuts worldwide would leave countries jostling to export their way out of trouble. The White House’s efforts to push an election-year jobs bill suffered a setback yesterday when Senate Republicans killed the legislation, citing its impact on the deficit.
“We must demonstrate a commitment to reducing long-term deficits, but not at the price of short-term growth,” Treasury Secretary Timothy F. Geithner and Lawrence Summers, director of the White House’s National Economic Council, wrote on the Wall Street Journal’s website on June 22.
The nightmare scenario for leaders is a repeat of the U.S.’s woes in 1937 and Japan’s six decades later when governments tipped their economies into renewed recessions by cutting support. In the mid-1930s, then U.S. President Franklin Roosevelt began chopping spending and raising taxes after an initial rebound only to lengthen the Great Depression. Japan’s government helped trigger another 20-month recession when it raised its sales tax in 1997 to 5 percent from 3 percent.
Nobel laureate Paul Krugman sides with Obama, arguing that with central bank interest rates so low fiscal policy needs to remain stimulative and markets aren’t signaling an immediate need to repair state balance sheets. Past fiscal turnarounds, such as Canada’s in the 1990s and Ireland’s in the 1980s, were accompanied by strong growth elsewhere in the world that aided exports or interest rate cuts, he says.
“We continue to need fiscal stimulus, we are depressed, we’re in danger of falling into a deflationary trap,” Krugman, a professor at Princeton University in New Jersey, said in a speech in Tel Aviv on June 22. The European push to balance budgets is a “deeply destructive move.”
Governments could still get a lift from markets by outlining how they will eventually clean up their budgets and tackling long-term fiscal challenges such as aging populations, says Ethan Harris at Bank of America Merrill Lynch.
Canadian Prime Minister Stephen Harper, who will chair the meetings, is seeking such a solution by calling on leaders to “send a clear message” that they will halve deficits by 2013. There is a consensus to maintain stimulus now with the focus on deficits in the “medium-term,” he said in a June 21 interview.
The best mix may be for Europe to lead the way, given the dollar’s reserve currency status will ensure it lures the foreign capital needed to plug its deficit, said Michael Amey, executive vice-president of U.K. fixed income in London for Pacific Investment Management Co.
“If everybody tightens at the same time then you have a big problem,” Amey said in a Bloomberg Television interview.