Prime Minister David Cameron’s austerity policies, which helped U.K. debt beat world peers in 2011, are backfiring in the bond market with the economy on the brink of a recession and borrowing needs approaching records.
Gilts lost 1.92 percent in the first quarter, the worst start since 1996, after returning 17 percent last year, according to Bank of America Merrill Lynch indexes. Falling revenue means government bond sales in the next 12 months will be 64 percent higher than the average over the past decade.
While Cameron came to power almost two years ago saying recovery from the worst financial crisis since the Great Depression depended on eliminating the budget deficit and preserving the nation’s AAA credit rating, his Conservative Party now trails opposition Labour in opinion polls. Gross domestic product is projected to shrink for a second quarter and reducing upper-income tax rates amid the biggest government spending cuts since World War II has traders leaving gilts.
“The government policies in the U.K. have succeeded in implementing more austerity than in stimulating growth,” Ed Yardeni, president and chief investment strategist at Yardeni Research Inc., said in a telephone interview on April 11. “Bond markets do well in weak economies, but not if weak economies are weak because they are saddled with huge, unsustainable debt.”
Let's review some UK stats:
The UK economy has contracted in three out of the last five quarters. While one of those contractions was mild (-.1%) one was actually worse than two quarters during the world wide recession (-.5%). This, or course, begs the observation: this was a really stupid time to think about austerity policies.
Total UK GDP is sill lower than at the height of the previous expansion.
The above chart shows UK debt/GDP. While it has been increasing, it's hardly at crisis levels.
The government budget deficit increased as as a result of the recession, during which two things happened: the UK aided the financial sector and increased social welfare spending.
However -- and this is the big rub -- the UK, so far, is missing the boat. What needs to happen is for the government to borrow cheap and then (drum roll please) invest. This does two things. First, it sustains growth during the slowdown. Second, it provides the platform from which future growth springs.
For example, see this article I wrote on my home town of Houston, Texas as a great study on the importance of infrastructure. Without public highways, Houston would be a shadow of itself. Instead, it's the 4th largest city in the US with a very strong local economy. However, the road system is key to the city; without it we'd be much smaller and far less important. And, the basic road system was built over the last 30 years and continually improved upon. Think about the return on that investment in terms of economic growth and development.
