Why George Soros is talking nonsense
This week's shock fourth-quarter GDP figures minus 0.5 % , are a harsh reminder that the British economy remains in distress.
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George Soros believes the UK Chancellor's austerity plans can't be implemented without pushing the economy back into recession
Household debt is still at near-record levels, barely a start has been made on getting the public finances back on to a sustainable footing, credit is still shrinking and private demand remains flat on its back.
Is it not folly, in such circumstances, to be launching, full-steam ahead, into the most severe fiscal consolidation since the immediate aftermath of the Second World War? To rub home the point, along comes George Soros to say the UK Chancellor's plans can't be implemented without pushing the economy back into recession. Would it not be better to delay until conditions are unambiguously better?
The answer to this question, which refuses to go away as an object of intense political and economic debate, is a definitive no. Plainly the Government must remain flexible in its approach to events, but the wobble in the economy makes it more vital still that the Coalition holds its nerve and the broad outline of the deficit reduction programme is stuck to.
People worry about the coming austerity, but actually, it is already here. While Mr Soros and much of the rest of the world's elite busy themselves with the irrelevancies of Davos, for ordinary mortals, grim reality is biting hard. The erosion of living standards referred to this week by Bank of England Governor Mervyn King may not have been obvious to high earners, but it is already painfully felt by almost everyone else.
As Mr King points out, Britain is heading for the most prolonged and biggest squeeze in real wages since the 1920s. It's not so dissimilar in many other advanced economies, and in some of the periphery eurozone nations, it's even worse.
Remarkable though Mr King's observation was, it was certainly in no way a revelation. Devaluation in combination with rising commodity prices, booming emerging market demand and increased sales taxes is causing UK inflation to outstrip wage growth by a wide margin. In some parts of the eurozone, nominal wages too are falling, and in most countries there is rising unemployment.
Mr King characterises this adjustment as part of a wholly necessary adjustment after years of living high on the hog. It's the price we have to pay, he says, for the financial crisis. It's also what has to be done to rebalance the UK economy away from credit-fuelled consumption to production, investment and exports.
As Mr King explained, monetary policy can do little to avoid this process of adjustment. The UK economy is being made competitive again, and to do this, relative living standards must fall. Ours is an inflationary adjustment, rather than the deflationary one we are seeing in parts of the eurozone. That makes it seem less painful, but over time the effect is much the same.
Central bank governors are meant to sound majesterial and omnipotent, so Mr King's refusal to accept that the Bank had in any way breached its remit by failing to grind down on inflation is perhaps understandable.
The Bank's own role in fostering the crisis by running too loose a monetary policy, and its complete misdiagnosis of the inflation risk since, are a column for another day. There will be no admission of error from Mr King until after he's retired, if then.
Whether culpable or not in the economic mess, Mr King is right to argue that monetary policy cannot do anything about the adjustment. Sure enough, he could have put up interest rates to counter external inflationary pressures, but by raising unemployment and mortgage rates, that would have made the squeeze on consumption even worse.
We needn't bother ourselves here with the sort of token interest rate rise urged by two members of the Bank's Monetary Policy Committee, which would have little effect on growth but might help signal the Bank is serious about inflation. The bottom line is that easy money may smooth and spread the adjustment, but it doesn't eradicate it.
The same is true of expansionary fiscal policy. However much publicly borrowed money is chucked at the problem, the best that can be expected of it is that it delays the consequences of the financial crisis. It cannot remove them.
Self-imposed fiscal austerity will always be politically very difficult, but it is far preferable to the austerity likely to be imposed by others – markets and the IMF – if action is ducked. Growth sustained today is only growth stolen from tomorrow.
Greece, Ireland, Portugal and Spain are all being forced to make their fiscal adjustment under pressure from the markets, which won't lend to them except at ruinous interest rates.
Britain has, admittedly, been under no such pressure. Spreads remain remarkably benign. That's in part because of massive quantitative easing (QE). By turning on the printing presses, the Bank of England managed, in effect, to finance about 85pc of the deficit in 2009. QE has now come to an end and cannot resume without further devaluing the pound and therefore adding to inflation.
The reason markets have remained benign despite the loss of QE support is that since then a credible medium-term deficit reduction strategy has been put in place. Without it, Britain might be in much the same place as Spain. The consequent recession would make the loss of economic momentum felt in the fourth quarter look like a stroll in the park. By voluntarily embarking on fiscal adjustment, Britain remains in control of its destiny.
As it is, a prolonged double-dip recession remains unlikely so long as the world economy remains on its present, above trend growth trajectory of 4pc to 5pc. Strong external growth ought to underpin resurgent investment and net trade. Unfortunately, that doesn't mean the adjustment to living standards is set to ease.
With rising taxes and public sector cuts now biting hard, the squeeze on consumption can only get worse. But the idea that you can somehow ignore one of the worst deficits in the OECD without experiencing the same drubbing that lesser offenders find themselves on the end of is just delusional.
Who knows? Maybe Mr Soros is right in thinking another UK recession is on the way. The misconception is to think this would be wholly avoidable were it not for the masochism of fiscal adjustment. In fact, deficit reduction is a vital building block for sustained economic growth.
Why George Soros is talking nonsense - Telegraph
