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Sometimes borrowers we must be Samuel Brittan: The Financial Times 10/10/03 Neither a borrower, nor a lender be; For loan oft loses both itself and friend. These sentiments of Polonius in Hamlet express the personal instincts of many of us. But they are hardly the last words in a modern commercial economy. Although Margaret Thatcher never lost an opportunity to advise young people not to spend more than they earned, her beloved homebuyers were borrowing on a massive scale. An irrational fear of debt lies behind the opposition to student loan schemes, even when repayment is strictly tied to income in later years. The shadow of the debtors' prison, which looms so large in the novels of Charles Dickens, still affects working-class culture. It would be better to switch to a graduate tax, which can have all the economic effects of a loan scheme. The biggest source of controversy in the Anglo-Saxon countries is, however, the rapid growth of consumer debt. It has been rising in the UK at an annual rate of 14 per cent and stands at a record of nearly 120 per cent of disposable income. A coalition of Cassandras warns that the apparent success of Gordon Brown, the chancellor, is based on an unsustainable mountain of debt. The coalition ranges from financial conservatives to left-leaning think- tanks, such as Open Democracy, which has voiced fears for "first world debt". The rise in the debt ratio is often explained by the boom in house prices. But that cannot be regarded as an independent force, to the extent that rising credit supports rising home prices, and the two could collapse together. The Bank of England's Autumn Quarterly Bulletin contains an analysis of the reasons for the jump in secured household debt - much the largest section of it. The rise in house prices relative to income plays a surprisingly small part. The biggest influences are the extension of home ownership, the reduction in inflation since 1985 and the associated fall in interest rates, which has reduced the burden of debt servicing. The author admits that his model does not explain the rise in secured borrowing since 2000. The Bank of England itself is clearly divided, with Rachel Lomax, the deputy governor, and Paul Tucker, the head of markets, nearer to the alarmist school. The most seriously argued alarmist analysis comes from Wynne Godley and Lex Izurieta of Cambridge, who argue that the consumer debt-to-income ratio has merely to stop increasing for UK consumer spending to be squeezed and economic slowdown or contraction to ensue. The most effective counter-argument comes from Goldman Sachs analysts, who maintain that most of the new credit has gone into the purchase of financial assets. It is in any case clear that real UK consumer spending cannot go on increasing at the rate it did in 1997-2002, the first five years of the Labour government, when it rose by a cumulative 21 per cent on the revised national income figures, compared with a growth of 14 per cent in gross domestic product. The discrepancy can be explained, without much reference to debt, by the slow rise in consumer prices relative to the prices of other GDP components. The downturn in sterling suggests that this is most unlikely to occur in the next five years. What will replace the consumer as the main motor of expansion? Public spending will be in the lead. The arguments against this are the same as those against too much of our incomes being spent collectively. There need be no threat to economic balance if taxes also rise. The government hopes that investment and exports will also grow much faster than in the past. If they do not, the Bank of England will have to keep interest rates lower than they would otherwise be - even if higher than they have been recently - to sustain demand. Such a policy would also help exports by pressing down on the exchange rate, even if it delayed an adjustment in consumer credit. The inflation target might interfere with a smooth landing. But it is not possible in a free society to keep a free economy on an entirely smooth path. The real rub of the Godley criticism is that the government has only one policy instrument - short-term interest rates - with which to meet its objectives. This is true if you want the government to have an instrument for affecting the components of GDP and, in particular, the balance of payments. But there is a second regulator, even if it is - wisely - not used as a policy instrument. That is the exchange rate, which is free to move whenever the financial markets start to worry about the size of the payments deficit. The foreign exchange markets may be inclined to overshoot. But there is little evidence that exchange rate management - which itself moves jerkily between reluctant adjustment and competitive devaluation - is any better.
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