Cheap UK borrowing costs? It's Gordon Brown we should be thanking, not austerity

The central plank of the coalition government’s economic strategy was made quite clear in the Chancellor’s autumn statement last week: austerity is needed to save Britain from the markets. Without strong measures to reduce public sector debt, interest rates on government bonds could be as high as Italy’s. We would lose our economic sovereignty and austerity would be imposed anyway, but not on our terms.

If anyone within the Treasury believes this nonsense, could they please step forward? Let's not forget that Greece, Spain, Portugal and now Italy have all embarked on massive austerity programs with little apparent impact on the price of government debt. Instead, austerity seems to have deadened growth, which has further worsened confidence. Given that the price of British government debt has gone the other way despite relatively less severe austerity measures, it would appear something else is going on.

The reason the UK is being favoured by the bond markets is because we have our own currency and our own Central Bank, as Adair Turner, Chairman of the Financial Services Authority, recently pointed out. That Central Bank can, if it so wishes, buy already issued UK government debt in vast quantities, flooding the UK financial system with liquidity, pushing down medium and long-term interest rates and boosting the confidence of investors. This it has done, to the tune of £275bn, and continues to do so.

As Turner points out, Eurozone member states have no such luxury. If their banks start looking shaky and investors begin to lose confidence, resulting in sharp increases in interest rates on government bonds, they have to go begging to the European Central Bank (ECB). But the ECB represents 17 countries, not one. If it engages in Quantitative Easing it affects policy in all members. The ECB has to tread a fine line. If every time there is a problem with bank lending in a given country it immediately steps in and buys its government debt, the result will be moral hazard. Banks and governments will have no discipline. The ECB will become lender of first rather than last resort.

The result, as Turner suggests, is that bonds issued by Eurozone members must be understood as fundamentally different financial instruments from those issued by countries with sovereign currencies and central banks. The economist Charles Goodhart calls them ‘subsidiary sovereigns’ distinguishing from the ‘full sovereigns’ issued by currency issuing states. Part of the cause of the Euro-crisis has been that these subsidiary sovereigns have been lapped up by banks who believed they had the same value as full sovereigns – i.e. that they were the safest and most liquid kind of financial asset it was possible to hold (apart from cash). As the private debt crisis has turned in to a public debt crisis the reality became clear. In giving up their currencies, Eurozone member states have lost one of the key powers of any sovereign government: the power to monetise debt. And the result has been crisis.

So Mr Osborne should stop trying to make the case that the UK would be a bond market basket case without austerity measures. Instead, he should be congratulating Gordon Brown for preventing the UK from entering the Eurozone and thus maintaining our monetary sovereignty and foreign investor confidence. But then, you’ve got as much chance of seeing that as you have of massive public sector job cuts boosting confidence in in the business sector.