Just when it seemed the small government ideal was dead and buried and Americans have fully embraced Euro-style socialism, Scott Brown’s win of the Senate seat for Massachusetts has sparked a new hope.
The Republican’s victory has dealt a shocking blow to Obama on the first anniversary of his inauguration. It was the third defeat for the Obama administration after Virginia and New Jersey elected Republican governors in November.
It is even more significant considering the largely unknown Brown won the seat held by Ted Kennedy for nearly five decades. And, Massachusetts is the bluest state in America – registered Democrats outnumber Republicans three to one. The last time a Republican won a Senate seat representing Massachusetts was in 1972. Both houses of the state’s legislature have been under Democratic control since the 1950s.
The voters have made it clear where they stand on the trillion dollar health care reform, growth dragging climate change and energy policies, exploding public spending and tax increases. They don’t identify with Obama’s tax & spend crusade that is leading the country to certain ruin.
Scott Brown’s was a message of lower government spending and across the board tax cuts to spur economic growth. A contrast to Obama’s trillions of dollars spending explosion and massive growth of government and government employment.
A recent Washington Post poll showed that, by 58 to 38%, Americans want smaller government and fewer government services.
People are dismayed at the scale of the debt and money printing. Most understand severe belt tightening is the only viable option for the country. It is now quite obvious that the discussed second stimulus bill will not become a reality. The people have said ‘enough’.
Brown’s victory resulted in a loss of the 60 vote super-majority Senate Democrats needed in order to prevent Republican filibusters. That could kill the health care bill as well as cap-and-trade, card check, tax hike plans and, most importantly, Obama’s aims to impose big-government rules on the free markets.
Still, it’s too early to say health care reform is dead. Obama may attempt to drive through the legislation regardless. The President is clearly unable to listen – to voters or any voice of reason, much less change direction from a defective strategy. Instead he opted to silence the noise about a dying health care bill by promptly announcing yet more ill thought out bank regulation.
However, one thing is clear. If Americans are once again lending their support to limited government, tax and spending cuts and free enterprise (as opposed to government) employment, the country’s future is bound to be brighter than the current situation might suggest.
UK heading into fiscal crisis
Meanwhile, no such good news from Gordon Brown’s Britain.
A new report by McKinsey shows that the combined UK public and private debt is now at 449% of GDP. Britain has seen the largest rise in debt to GDP of any western nation over the last 10 years. Even excluding the liabilities of UK based foreign banks the ratio is still at 380% – far higher than any country except Japan. See international debt chart here.
Given that the UK seems to have no clear plan or ability to reduce its monstrous deficit, a full blown fiscal and currency crisis is a near certainty.
The public sector deficit as percentage of GDP is now more than twice what it was in 1976 when Britain was bailed out by the IMF. Apart from being at a record level, much of the deficit is structural, as the financial and housing sectors will account for a significantly smaller portion of the economy compared to recent years. OECD believes about ¾ of UK’s deficit is structural, and as such unlikely to prove responsive to any cyclical recovery.
To make matters worse, spending on health care and pensions will also increase significantly in the coming years and decades, due to massive demographic challenges.
As the budget deficit has swollen to nearly 13%, the UK has had to keep issuing gilts at a breathtaking pace to finance the gap. The markets are unlikely to be patient with our policy makers for too long. Overseas holders of gilts (accounting for nearly a third of outstanding government debt) are increasingly reluctant to put up with the risks of UK’s disastrous public finances.
The world’s largest bond investor Pimco, as well as BlackRock, have recently started to sell off their gilt holdings. Pimco stated an 80% probability of a UK ratings downgrade this year. Thanks to a (still ongoing) massive quantitative easing program the Bank of England now holds almost 30% of outstanding gilts (compared to just over 5% in March 2009).
As the IMF expects UK’s net debt to GDP to rise to over 100% by 2014, things are bound to continue deteriorating. Investors will undoubtedly demand higher risk premiums on UK debt, further worsening the fiscal situation. A full blown debt crisis, and resulting currency crisis, are increasingly likely.
The Bank of England is unlikely to exit extremely loose policies and hike rates or withdraw liquidity soon. The markets will of course force it to act eventually. The pound has already fallen some 25% from its highs and the gilt/Bund spread is now wider than 70bp.
And it’s not just Gordon Brown’s government’s fiscal consolidation strategy that lacks any credibility; the Conservative plans aren’t faring much better at the moment.
Instead of much needed expenditure cuts the December Pre-budget report offered more spending (or ‘investment’ as Labour prefers to label it) and commitments to ring-fence many areas from any cuts.
Public spending makes up 47% of UK GDP, more than in 1976. Yet instead of coherent and detailed plans on expenditure control and public pension system reform we’ve got soak-the-rich class war policies, tax raids on banks and political posturing.
It’s clear that if the UK is to get the situation under any sort of control, sacred cows need to be sacrificed. And yet all main parties are competing to ring-fence the bloated and inefficient NHS with its £120 billion annual budget (up from £29 bil in 1990 and £49.5 bil in 2000) as well as areas like overseas aid, and commit to unaffordable and unnecessary climate change spending.
Preventing a bigger crisis will require considerable political leadership and courage, and we aren’t seeing much of those at the moment. Any significant action would also prove near impossible should the UK get a minority/coalition government, which is a possibility after the (May or June) general election.
McKinsey sees three possible directions for the UK – outright default, high inflation or severe belt-tightening. While voluntary austerity would clearly be the best solution for the long term health of the economy, the short term pain – and voter resentment – it would bring make it a rather unlikely choice.
Sacrificing short term growth and employment in order to generate a more sustainable growth for the future doesn’t appeal to a population that has, for too long, been used to times of prosperity and welfare largesse. The bill will, I’m afraid, come in a few years time. And the pain is likely to be far more severe and prolonged than anything we’ve seen in the last couple of years.