Britain balancing its books part 1

Britain balancing its books part 1: Sound public finances underpin living standards, discuss

Zoso Davies, a credit strategist and Hartej Singh, a Credit Investor write a four-part series arguing that balancing the books should be the UK government’s number one priority. With living standards, immigration, climate change, and choppier geopolitical waters dominating national discourse, this may seem blinkered. We firmly disagree. In our view, the very ability to live well, invest in our future, and defend ourselves depends on the credibility of UK PLC. As stewards of long-term savings, we feel a personal responsibility to make this case. These are our personal views and not the views of any institutions we are affiliated with.

The flow of our 4-part series

1.    Why it matters now (today): Sound public finances underpin living standards

2.    What’s broken: More promises than productivity

3.    The moral case: What about the children?

4.    How to fix it: Efficiency, transparency, growth and credibility.

Government accounts matter in the macro as well as the micro

Britain’s public services, pay packets, currency and mortgage rates all depend on a dull idea: sustainable public finances. When investors believe the numbers, the pound is steadier, the state borrows more cheaply, and both families and companies benefit from a lower cost of finance. When investors do not believe, the bill arrives quickly – as seen during the Liz Truss mini-budget crisis of 2022. Getting public finances onto a sustainable path isn’t a theoretical exercise, it is a necessity for growth, resilience and fairness.

And yet commentary on public finances tends to focus on what are, in aggregate, small details. Conversations around spending will focus on law and order, pensions and the NHS. Fuel duty and inheritance tax will be scrutinised in detail. But one thing that will be largely glossed over in the discussion is that government debt will continue to rise, both in absolute terms and relative to the size of the economy, now and for the foreseeable future. Focusing on the details was a luxury we could afford in the past because the big-picture for government finances was “good enough”, but that is no longer the case. We need to zoom out.

Chart 1: National debt loads are growing

The UK Government has spent more than it took in for 25 years. In 2024/5 it spent £1.279 trillion and only took in £1.141 trillion in receipts, 12% overdrawn. The debt clocked up now totals £2.7 trillion, nearly £40,000 for each man, woman and child. And yet indifference to how government spending is paid for is rife – none of the major parties currently offer a credible plan to balance the books.

Chart 2: Deficits for this year

Chart 3: Spending has grown faster than revenue

The UK is no stranger to debt crisis

A sovereign debt crisis occurs when investors lose confidence in a government’s ability to manage its debt and/or service its debt obligations. Yields on government debt rise and currency weakens as investors become wary of potential default and devaluation risks. The idea is not abstract; over the last 50 years the UK has had three fiscal confidence crises - twice under Conservative governments and once under Labour.

• 1976 IMF crisis: After years of overspending without an inflation-reduction strategy, the Labour government found itself unable to roll over debt at affordable rates. The pound collapsed, reserves bled away, and Britain had to go cap-in-hand to the IMF for the largest loan in its history. The political cost was severe: loss of sovereignty and a reputation for mismanagement that tainted the Labour party for a generation.

• 1992 Black Wednesday: The Conservatives had tied sterling to the Deutschmark at an unrealistic level under the Exchange Rate Mechanism. When the UK economy weakened, the peg became indefensible. Ministers hiked interest rates twice in a day, burning billions in reserves, but the markets broke the pound anyway. Sterling crashed, credibility in economic management collapsed, and the party’s reputation was damaged.

• 2022 gilt shock: The Truss–Kwarteng “mini-Budget” promised £45bn of unfunded tax cuts while sidelining the Office for Budget Responsibility. Markets saw it as reckless. Gilt yields soared, mortgage rates spiked and defined-benefit pension schemes came close to collapse before the Bank of England intervened. Within weeks, the Chancellor and Prime Minister had “resigned”.

Linking these events is the sidelining of sound, fundamental, economic constraints. When a government borrows, it becomes a price taker. Markets can force it into expensive and humiliating retreats. Fortunately, each of those episodes stopped short of severe distress, but we cannot bank on being that lucky forever.

Whilst the UK is not Greece (not least because we borrow in our own currency) there is much to learn from the Greek experience. The bottom line is once credibility goes, choices narrow, and the pain lands on you and me. 

The Greek experience: a generational crisis

When Greece’s finances unraveled after 2009 (having been a single A rated country in 2006), the adjustment was unexpectedly brutal and lightning fast. Between 2010 and 2018, Athens was forced to agree to dramatic spending cuts in return for EU/IMF bailouts. The public sector wage bill was cut by 10% in a single year. Pensions were trimmed repeatedly, with higher pensions cut by up to 40%, retirement ages were increased, and early-exit routes closed. Greek government bondholders suffered a principal loss of 53.5% (ex. the ECB).

Chart 4: Average Annual Greek wages has decreased by over 25%

The trouble did not end there. Pressure spilled over into the banking system. In June 2015, as bailout talks stalled, capital controls were imposed: banks shut for nearly three weeks, ATM withdrawals were capped at €60 per day, and overseas transfers all but froze. Access to cash and liquidity was severely rationed until the controls were fully lifted in September 2019. The economy shrank by a quarter, unemployment peaked above 27%, and living standards fell sharply.

With falling living standards, there was what some Greek media outlets termed the “Great Exodus”, a large outflow of Greek Nationals. According to Eurostat more than half of those that left during this period were aged 20-39. According to the Hellenic Observatory this was highly skewed towards graduates and postgraduates. This mattered not just because the numbers were large, but because emigration compounded the economic damage: Greece exported its youngest and best-trained workers, just as the country needed them most.

Chart 5: Greek net migration

We are certainly not suggesting that the UK’s position is as severe as Greece in 2009. The point is to emphasise that national finances are not just “an accounting exercise”. When a country “goes broke”, the pain to households is real - wage packets, pensions, bank access, demographics and daily life take the hit. And before we get complacent about the UK being too sensible to enter distress, it should be noted that most economies end up crashing at some point. Since 1700, 80% of economies have experienced significant devaluation or default according to Bridgewater Research.

Can’t the government just print money?

Governments differ from most borrowers in one critical way - they effectively have a captive lender in the form of a central bank. Sometimes this is explicit, in economies where the central bank is not independent. But even independent central banks have shown a willingness to finance governments in periods of stress, to maintain financial stability. This has led to a surge in the popularity of the idea that the UK could never suffer a bond market crisis as it could finance itself via the Bank of England - one version of this is Modern Monetary Theory (MMT).

However, central bank financing rarely ends a funding crisis. Indeed, it will often exacerbate it. Either by triggering a currency devaluation, or because long-term rates rise in response to the erosion of institutional strength. Turkey is one example. Domestic mortgage rates are now 43% and the Turkish Lira has lost 93% of its value versus the US dollar over the last 10 years.

Higher mortgage rates, a weaker currency and higher inflation are just some of the potential costs for UK households if the government finances itself via the central bank. Although MMT did gain some traction in the low-inflation period from 2010-2020, the crippling inflation experienced post the Ukraine war quickly snuffed out the idea that nations can keep printing their currency without suffering ill effects. MMT and calls for the UK government to finance itself via the BoE fail to heed the lessons of history.

The first step is admitting you have a problem

The UK faces not a certain, but a very credible risk of a debt crisis. Soon.

This is not a statement either author makes lightly, not least because there have been endless doomsday forecasts about public finances since 2009. Indeed, both authors have generally found themselves arguing against hyperbolic Pollyannas over the last 15 years. Therefore, it is a significant step for us to, jointly, call for the UK to balance the books now.

Why are we so worried about the UK’s fiscal position, far from unique across developed nations? First and foremost, because we both live here and whilst a debt crisis overseas would be of professional interest, the UK is our home. Secondly, the risk of a crisis is higher now. For most of the period since 2009, inflation was below target and central banks were able to create money to absorb government debt without endangering their inflation credibility.

But since 2021 inflation has risen. Central banks now must weigh up supporting the economy versus managing inflation. Likewise, Chancellor Reeves must weigh the pros and cons of further borrowing carefully: it now comes with far greater risk. In fact, we believe that the balance of risks is firmly tilted away from further government spending and toward the treasury prioritising its credibility.

Finding solutions, not just problems

We believe that the best way forward is for the UK government to make hard choices today, to avoid even worse choices in a crisis. To borrow from regulators after 2009, the cost of a crisis is so high that we should be willing to endure significant discomfort, now, to avoid one.

Action now allows choices to be made deliberately, spread costs fairly and build resilience. If it is embraced as a national priority rather than billed as a choice, fiscal repair becomes a lightning rod of positive action. In a world full of uncertainty, rebuilding fiscal flexibility is a national security imperative.

In part two of this series, we try to answer the question “What’s broken?”, by examining the underlying imbalance of government spending and taxation.