"We are in danger, if the Government is not careful, of having a proper sterling collapse, a run on the pound.What is the economics behind this?
"The danger of a run on the pound . . . is that it pushes up long-term interest rates, which is a huge burden on the economy.
"The more you borrow as a government the more you have to sell that debt and the less attractive your currency seems."
1. Increased government borrowing is not going to cause a run on the Pound. UK public sector debt is 43% of GDP. Arguably this underestimates national debt because government exclude PFI. But, even so, it compares favourable with
- US national debt $10 trillion - 72% of GDP
- Italy national debt - 107% of GDP
- Japan national debt - 194% of GDP
- National debt by country
2. He suggests higher borrowing could push up long term interest rates (financial crowding out). This is certainly possible. But, higher interest rates would make demand for sterling stronger, not weaker. Higher rates may be damaging for economic growth, but, not sterling. Anyway I doubt interest rates would rise that much from a temporary increase in borrowing. Interest rates in Japan and US are low despite much higher levels of borrowing.
3. You could argue higher borrowing is inflationary, especially if Government started to print money. But, the MPC forecast inflation could fall below 1% in 2009, so this is not a real concern at the moment.
4. You could argue tax cuts are ineffective in boosting spending and economic growth. Many economists would support this. But, being ineffective doesn't mean there will be a run on the pound.
5. The fall in the value of the Pound e.g. 25% fall against dollar reflects
- a more realistic long term value. At $2 to £1, the £ was really overvalued making American goods ridiculously cheap.
- Sharp decline in UK interest rates and prospects of more rate cuts to come.
I feel the shadow chancellor is using rather sloppy economics. He could criticise the government for borrowing too much in the boom. He can criticise the tax cuts as ineffective. But, to claim that modest tax cuts will cause a run on sterling, sounds as if he is searching for arresting sound bites rather than offering a reasoned understanding of the economy.
See also: The economics of tax cuts