It isn’t hard to find reasons to feel gloomy about the prospects for the British economy. Growth remains sluggish and we may well find ourselves in the middle of another recession by the start of next year. Unemployment is rising, retail sales are slack, wages are falling, and house prices are stagnant. But maybe we are missing the real story – Britain could well be undergoing a fairly promising correction.
There is no question that Britain is one of the most indebted countries in the world. According to figures calculated by the McKinsey Global Institute, by 2008 UK debt reached a towering 489% of GDP. It was the highest in the developed world. Japan was second with 459%. Household debt came to 101% of GDP, non-financial corporate debt accounted for 114% of GDP, while the financial sector and government debt accounted for the rest. In short, Britain was maxed out on credit.
After the credit crunch, that was always going to make growth a long, hard, slow slog. The country had to de-leverage and get those debts back to a manageable level. That was never going to be easy. Paying down debt takes hard work and a lot of saving. There was, however, an easier way out. Instead of paying off its debts, Britain could simply inflate them away. Critics of fiat money – that is, money that is simply printed by the central bank – usually make the point that the temptation is always there to inflate away your debts. This is usually presented as a bad thing. And, of course, in many ways it is. Responsible savers get punished. Profligate borrowers get bailed out. There is nothing virtuous about it. The fact that we may disapprove of it, however, should not lead us to ignore the possibility that it may work.
So how is it going? If you look at Britain as an economy trying to inflate its way out of trouble, it is doing a good job. Just consider some of the figures. British interest rates have been held at a 300-year low of 0.5% for almost three years now. They show no sign of being raised anytime soon. Inflation has nudged up past 4% and may well hit 5% before it peaks. Who knows, it could even hit 6% or 7% – it’s only the Bank of England (BoE) that forecasts it will come back down again next year, and its forecasts now have about as much credibility as the Greek finance ministry.
But overall debt levels are starting to turn down, on the latest McKinsey figures, as borrowings get re-paid. According to BoE figures, UK households are now running a financial surplus of 2% of GDP. Through most of the last decade, they were running deficits of between 4% and 5% of GDP. So collectively we are repaying our debts and not taking on new ones. The corporate sector is running an even bigger surplus, amounting to 6% of GDP. That is far higher than either America or the euro-zone. So corporations are paying down debt as well. Of course, the government is still racking up fresh borrowing on a vast scale. But even that is starting to stabilise.
More interesting still are the figures in real terms. Debt is calculated in nominal terms, not real terms. So if you owe £100, and pay back £2 a year, it is going to take a long time to get it all paid off. But if inflation is also running at 5% a year, and you are repaying debt, it is going to come down pretty quickly when you measure it in real terms.
Inflation is pushing down real wages as well. Right now, average wages are growing at a rate of around 2% annually – slightly above that figure in the private sector and slightly below it in the public sector, where there are widespread wage freezes. So, in effect, wages are being cut by 2%-3% annually. Compound that up and over a five-year period we are going to see a very substantial cut in earnings. That is painful for the ordinary families involved. But it is good for the economy. It makes our firms a lot more competitive. In France, for example, wages are growing by 2% annually in the latest quarter, roughly the same as eurozone inflation. They are static in real terms, while British wages are falling.
The pound has been substantially devalued – since 2008, it has dropped by about 30% against its major trading partners. It may well fall again: countries with rapid inflation usually see their exchange rates fall sharply in value against harder currencies. Add up the internal devaluation – the cuts in real wages – and this external devaluation and Britain may soon be one of the most competitive major developed nations.
There are risks, of course. We have no way of knowing whether inflation will stay under control. Moderate inflation might be doing a lot of good, but putting the genie back in the bottle once it has been released is not going to be easy.
Moreover, the Bank of England hasn’t owned up to the fact that it is trying to inflate away our debts. But just because a policy is immoral and dishonest doesn’t mean it isn’t going to work. So long as hyper-inflation and a currency collapse can be avoided – and there is no sign of either yet – Britain may well emerge in a few years’ time with relatively low debts and in decent competitive shape. Given where we started from, that would be quite an achievement.