Is It Time for Britain to Call in the Auditors?

When the International Monetary Fund (IMF) expresses major concern about a "financing gap," most of us think of Latin America in the 80s, or perhaps South East Asia in the late 90s. It may surprise some of you that this term was used by Jose Vinals, lead author of the IMF's Global Financial Stability Report, to describe the current state of the United Kingdom's fiscal position.
 
Whenever I speak to colleagues and friends outside of the UK they find it hard to fathom that a country considered to be one of the preeminent financial centers of the world has a fiscal position akin to that of a banana republic.
 
On a number of occasions (here, here, and here), I have discussed why the UK will face a longer road to recovery than her European counterparts. But now it is time to focus on just how severe the problem actually is.
 
According to a report in the London Daily Telegraph, the "UK faces a so-called annual 'financing gap' of £215 billion – 15 percent of gross domestic product – this year and next between what people need to borrow to keep the economy in good health and what they actually can lay their hands on. This compares with a gap of a mere 2.4 percent in the US and 3 percent in the eurozone."
 
The report added that the UK is "most susceptible to credit constraints... given its significant reliance on the banking channel and the projected sharp decline in domestic bank balance sheets, as well as substantial public financing needs." And yet the Prime Minister believes that Britain is better positioned than any other major economy to weather the storm.
 
Just last week there appeared to be an emerging consensus across the political spectrum that spending had to be cut. Unfortunately, in what is likely to be his swansong speech as Prime Minister, Gordon Brown demonstrated little zeal for making the necessary cuts in spending. Instead he ran down a list of "extravagent" spending pledges. Later reports indicated that the government would cut the deficit in half through asset sales and spending freezes so they wouldn't have to increase taxes. The extent of Brown's spending freeze is crucial to restoring some sort of fiscal balance. Asset sales can only artificially hide government deficits for a limited period, as they did in Argentina.
 
So what of the government-in-waiting Conservative Party? Having previously pledged to follow Labour's spending commitments, Conservative Party leader David Cameron's sudden promise to rein in spending may well lack some credibility, especially as it has come on the heels of several public opinion polls calling for fiscal restraint. That being said, Cameron is seeking to tackle the issue and will have to convey to the British people that there will be some short-term pain in order to restore long-term health to the public finances.
 
Cameron would obviously not state this publicly, but it would be much more politically expedient if history repeated itself and the Labour government was forced to go cap in hand to the IMF for a bail out, as it did in 1976. On that occasion, the Labour government was forced to make drastic spending cuts that, as a whole, made Margaret Thatcher's job a little bit easier. That's not to say that with an IMF intervention things are going to be easy, but a radical process of restructuring and short-term pain may well set Britain on a more long-term prosperous path.
 
And even government ministers have claimed that there is no longer a stigma attached to receiving IMF funding.
 
Still, it's clear that the British government seems more commited to pursuing an economic scorched-earth policy rather than balancing the books. So a timely intervention by the IMF would be a boon for the Conservative Party on two counts: It would be humiliating for Labour, and would give the next government the necessary political capital to make the cuts our fiscal position so badly requires.
 
Some say that history repeats itself, and that Labour governments always end their tenure in office leaving a trail of red ink and IOUs. It may well also be the time to call in the auditors. Again.
 
(Image: Prime Minister Gordon Brown, when he was UK Chancellor of the Exchequer, at IMF Headquarters, Sept. 29, 2002)
 
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