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Is the UK on its way to its first ever debt default? Coronavirus bonds could be storing up a whole heap of trouble

No government as ever taken on such a level of debt whilst also deliberately running down the economy

Bank of America -

Global economies are now on a war footing.

If you doubt it just listen to President Trump’s rhetoric, watch Boris Johnson’s Churchillian posturing, or focus for a short period on the wall-to-wall coronavirus media coverage

“Coronavirus has hospitals on a war footing,” said the Guardian, late in March; “Trump puts US on war footing,” said the BBC; “UK war footing continues,” said the Independent.

But if you want real confirmation that the world is now on a war footing look no further than the bond markets.

Statistically, the level of borrowing now being incurred by western governments is comparable only to wartime financing regimes. No borrowing on this scale has ever been attempted in peacetime.

For the politicians and apparatchiks are implementing this new policy, wartime rhetoric seems more than appropriate. In fact, it’s essential.

Thus, the head of the UK’s Office for Budget Responsibility, Robert Chote, recently told a Treasury Select Committee that the government should be borrowing as if it was “wartime.”

Never mind that the OBR was set up to keep watch for excessive debt.

“Now is not the time to be squeamish,” he said. “It’s more like a wartime situation, this is money well spent.”

Accordingly, the UK will issue £180bn of debt between May and July, more than it had previously planned for the entire financial year.

The country's overall debt now exceeds US$2.5tn and public sector net borrowing could reach 14% of gross domestic product, the biggest single year deficit since World War Two.        

At the same time, analysts expect a double digit contraction in the economy this year, the largest since records began.

And that’s a key difference.

Because, back when there was a real war – the invariably invoked World War Two, the world’s economies were allowed to go full tilt. To put it another way, they were borrowing, yes, but they were also producing fit to bust.

This time round, the borrowing is being incurred in the context of an enforced curtailment of production, and you’re whistling in the wind if you think you can forecast how much of that production is actually going to come back on line when Mr Johnson’s government tries to flick the switch.

Will the money be there to service the debts? So long as there is a taxpayer base, then of course it will.

But the question that has to be asked - in an era in which almost every major institution of state has been undermined systematically for decades - is what the cost will be elsewhere?

Will a state whose institutions wield power without credibility be able to convince a sceptical electorate to continue paying debt interest to financiers and central bankers at the expense of a further deterioration of the UK’s services, already routinely described by the press as “crumbling”?

Don’t bet on it. Other countries sometimes don’t. Instead they do something else – they default.

Now, students of economics know that defaulting rarely ever helps, and the British government knows this too.

So, to try to get round the risk of default they employ something called modern monetary theory, aka printing money.

The Americans are doing this too, so it’s not a uniquely British vice, but it will, in the end, lead to trouble wherever its employed.

Put in its simplest terms, the respective central bank electronically “generates” – or prints – new money, which it then uses to buy the bonds that the respective government is selling. The central bank thus becomes the cornerstone investor, which encourages other market participants to throw their hats into the ring.

The “modern” part of this monetary theory is that the introduction of new money is so skilfully managed that inflation doesn’t infect the system and economic stability is maintained.

Last time round they called it “quantitative easing,” and in spite of its relative success it was noticeable that the one currency that remained beyond the central bankers’ control, gold, soared in value.

This time round, the application of MMT hasn’t really got a monicker yet, other than the continued references to “wartime” financing. But be that as it may, gold is already on the move, and some analysts expect it to go much, much higher.

Last week, indeed, Bank of America forecast a rise to the US$3,000 mark. For anyone wanting a more detailed explanation, aside from vague prognostications about “safe havens”, modern monetary theory is the place to go.

Because the most effective way for governments to default on debt without actually ever defaulting, is to manage inflation in such a way that the value of the debt simply fades away. Even before the coronavirus panic we had the currency wars. Expect them to open up on a new front now: it won’t just be country against country now, it will also be central banks against investors.

It’s a context in which a straightforward default, ordained by an electorate wearied by long years of financial shenangigans from markets and central bankers, starts to make a lot more sense. After all, it’s not us that will have to pay this money back, it’s our unborn grandchildren, who bear no responsibility for this mess whatsoever.

You have been warned.

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