I recently discovered a very good article at prudentbear.com, published shortly before the general election.
Martin Hutchinson considers “the three previous occasions on which Britain’s debt and deficit position took the country near bankruptcy”:
these are 1945, 1931 and 1815. Two of these occurred when Britain’s debt level at the end of ruinous wars approached 250% of GDP – about double the level of Greece’s today; the third was in the middle of a disastrous world slump, following a decade of stagnation after another devastating war.
The approach to the 1945 crisis was decidedly Keynesian:
Keynes’ activities at Bretton Woods however left one extraordinarily valuable legacy to the incoming Attlee Labor government: an international monetary system which pretended to fix prices in terms of gold but in practice didn’t. For the first twenty years after World War II, British Chancellors of the Exchequer were thus able to fool investors and borrow at traditional interest rates in the 2.5%-4% range, while running rates of inflation often considerably higher than that. This devastated the British middle class – “euthanizing the rentier” in Keynes’ odious phrase – but made the real value of British government obligations decline rapidly at the rentier’s expense.
The government’s tactic in 1931 likewise involved debasement of Sterling:
The solution this time was to abandon the Gold Standard, thus making British exports about 20% more competitive, while at the same time cutting government spending sharply, reducing civil servants’ salaries by 10% on the rather sophisticated ground that the option value of their job security was higher in a depression.
Hutchinson says we should instead focus on the radically different approach taken in 1815:
Both these solutions involved a certain amount of economic flim-flam, either fooling investors about inflation as in 1945 or unilaterally devaluing the exchange rate as in 1931 (which helped because Britain’s obligations were almost all in sterling). The most interesting debt crisis is thus that of 1815, in which neither expedient was adopted by Robert, Lord Liverpool, prime minister at the time. Instead of inflation, Liverpool restored the pound to the Gold Standard at its pre-1797 parity, thus forcing a price deflation of over 20% within a few years, while at the same time providing a benchmark of currency stability for the world and facilitating the emergence of the City of London as the capital of world finance. Liverpool cut public spending to the bone, protected British agriculture from the worst consequences of deflation through the Corn Laws and adopted a policy of determined resistance in the face of the inevitable unrest.
The result was a “double dip” recession of considerable severity, exacerbated by 1816’s “Year without a summer” famine (caused by the 1815 eruption of the Mount Tambora volcano). However Liverpool’s courage and determination were rewarded after 1820 by an astonishing boom, in which the Industrial Revolution transformed Britain’s economic prospects, sent British living standards into a century-long upward trend and reduced the burden of debt to a manageable and eventually benign level.
Here at the Cobden Centre, we take a different view of the Corn Laws, but Hutchinson is right to highlight the long term growth that is facilitated by a stable currency.
Contrary to the gloom of Mervyn King, therefore, the new incumbent of No.10 will have a choice of three approaches to Britain’s problems, all of which might in principle succeed. One would be to follow Attlee and Keynes, and inflate Britain out of the problem. Unfortunately investors today aren’t as naive as those of 1945-65, so interest rates on government debt would soon rise to levels higher than the inflation, preventing the desired result.
A second would be to follow Chamberlain, devaluing the pound to about $1.20 and attempting to export Britain’s way out of trouble. That might well work; its problem is that Britain’s principal trading partners are now the jealous EU rather than the friendly Empire, so no equivalent of “Imperial Preference” would be available to assist the process. More likely, the EU and Britain’s other trading partners would erect non-tariff regulatory barriers against British exports, particularly of financial services, thus preventing a replica of the splendid recovery engineered by Chamberlain.
The final alternative would be for the new prime minister to cut public spending to the bone, follow a “hard money” monetary policy (which would probably require him to replace King), steel himself to the inevitable shrieks of anger from the media and the big-spending interests, and wait for the newly liberated private sector to produce a second Industrial Revolution. As for Liverpool and Castlereagh, that would almost certainly work. Re-election might indeed be difficult, but Liverpool managed it twice, in 1818 and 1820.
We propose a fourth alternative: a transition to 100% money that allows us to pay off the national debt.
There is a fifth option, proposed by the true Enemy of the State and anarcho-capitalist Murray N Rothbard: to repudiate the national debt. This suggestion inevitably arises, and it deserves some comment:
- Rothbard refers to a Marxist/Socialist politician, who debated with Mises in the 20’s during the Socialist Calculation Debate,
In the famous words of the left-Keynesian apostle of “functional finance,” Professor Abba Lerner, there is nothing wrong with the public debt because “we owe it to ourselves.” In those days, at least, conservatives were astute enough to realize that it made an enormous amount of difference whether – slicing through the obfuscatory collective nouns – one is a member of the “we” (the burdened taxpayer) or of the “ourselves” (those living off the proceeds of taxation).
- Rothbard points out the enslaving nature of a public debt instrument on private tax payers in his characteristically beautiful and eloquent prose, and he is right of course.
The public debt transaction, then, is very different from private debt. Instead of a low-time preference creditor exchanging money for an IOU from a high-time preference debtor, the government now receives money from creditors, both parties realizing that the money will be paid back not out of the pockets or the hides of the politicians and bureaucrats, but out of the looted wallets and purses of the hapless taxpayers, the subjects of the state. The government gets the money by tax-coercion; and the public creditors, far from being innocents, know full well that their proceeds will come out of that selfsame coercion. In short, public creditors are willing to hand over money to the government now in order to receive a share of tax loot in the future. This is the opposite of a free market, or a genuinely voluntary transaction. Both parties are immorally contracting to participate in the violation of the property rights of citizens in the future. Both parties, therefore, are making agreements about other people’s property, and both deserve the back of our hand. The public credit transaction is not a genuine contract that need be considered sacrosanct, any more than robbers parcelling out their shares of loot in advance should be treated as some sort of sanctified contract.
However, I know many completely naive, lovely, well-meaning, innocent people who give their money to pension funds in good faith and have no idea that “fixed income” means pledging to extract wealth from taxpayers. This would not even occur to most of them.
So I could not countenance a Rothbardian repudiation, but rather an outright ban on government ever raising debt unless the majority of the House of Commons and House of Lords (over 50% in each) voted to extract the wealth of the people. At least it would be the people’s representatives doing this, and not the Executive and their agents. Needless to say the “Day of Reckoning” article listed above does provide a painless solution to the National debt and deficits.