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Welcome to the UK death spiral

It is more than a decade since retired insiders from the energy industry warned of the potential for an energy-death spiral.  The idea – which was born out by the collapse of hundreds of energy retail companies following lockdown – was that as the cost of energy rose even as consumers’ ability to pay fell, energy companies would be forced out of business.  This, of course, is no different to what happens with any business whose overheads are higher than its income.  But unlike businesses in the discretionary sectors of the economy, nobody could be sure what would happen with something as essential as energy.

One way or another, it was predictable that, faced with a crisis, the government would have to step in.  A sensible way forward would be to allow the energy companies to go bust and then have the state nationalise and recapitalise the assets.  This though, goes against the neoliberal ideology embraced by all of Britain’s establishment political parties.  And so, instead we were treated to a £36bn bailout of the energy companies last winter, and there is speculation about more to come this winter too.

Bailouts – as with banking – however, are a mere sticking plaster – albeit a horrendously expensive one – designed to avert the immediate crisis while doing nothing to change the underlying dynamic.  With the majority of the UK population now having to cut their spending, energy conservation has been an obvious target.  Simple changes like wearing extra layers around the house, plugging drafts, and only heating one room rather than an entire house, have helped people make big cuts to their bills.  Meanwhile, at the bottom of the income distribution, heating has been almost entirely abandoned.  But this does nothing to reverse the death spiral for the energy companies, whose wholesale prices are increasing even as, collectively, our consumption has collapsed.

Indeed, because of the UK’s antiquated system of standing charges – the price we pay just for being connected to the grid – the government is under increasing pressure because thousands of households have reached the point at which further savings are impossible.  With no obvious end in sight to the new reality of expensive energy – in part the result of sanctions on Russian gas, in part a consequence of the headlong rush to deploy expensive wind energy – government will face increasing pressure to subsidise household bills either across the board or through various additional payments to those on pensions, benefits and low incomes.

What few people have factored into their thinking is the – growing – likelihood that government – irrespective of which party is elected – may be losing its ability to act.  That is, the state itself may be facing a death spiral of its own.  Indeed, we are seeing the early phases of the government death spiral unfolding across local government.

Yesterday, Birmingham City Council – the largest local government in Europe – declared the equivalent of insolvency, filing a Section 114 notice, to protect its essential spending.  The trigger for the filing was an order to pay £760m to settle historic equal pay cases.  However, the council was already running a deficit budget of £87m and was servicing a modest (by local government standards) £120m debt.

With tedious predictability, the commentariat leaped on the fact that Birmingham is a Labour (mis)run authority which had spent billions on net zero and diversity projects.  And no doubt, given what is coming as Britain’s surplus energy disappears in the rear-view mirror, such initiatives are bound to come in for scrutiny in future.  But as council “bankruptcies” go, Birmingham’s is manageable.  Indeed, less publicity has been afforded to councils like Tory-run Thurrock (£470m in debt) Labour-run Croydon (£1.6bn in debt) and Lib-Dem Woking (£2bn in debt) which have spent the past decade using low interest rates to borrow extensively rather than balance their books.  Indeed, by some estimates, half of the councils in England and Wales could be bankrupted as interest rates rise, income falls, and spending commitments (such as housing benefit, child support, and social services) spiral upward.

In large part, the plight of Britain’s councils is due to the 2010-15 Cameron government’s decision to make local authorities pick up the tab for bailing out the banks.  As Mark Sandford writes for the House of Commons Library:

“Local authorities in England have seen considerable reductions in the grants they receive from the Government since 2010. The National Audit Office estimated in 2018 that local authorities’ spending power had fallen by 29% in real terms between 2010/11 and 2017/18.”

The Cameron government also imposed restrictions on local councils’ ability to raise additional taxes:

“Councils needing additional income can raise their council tax. This cannot be done mid-year and therefore any additional income from this source would take some time to appear. Since 2012, the Government has set national limits on the amount council tax can be raised by annually – typically by around 2-5%. The Autumn Statement in November 2022 stated that the limit for 2023/24 would be 5% for councils with social care functions.”

Given the growing problems that central government has in managing its own bloated debts, history may judge these cuts and restrictions to have been a prudent measure.  Although given the catastrophe of an EU referendum promised solely as a pre-election gimmick to earn the Tories a few extra seats in 2015, it is hard to credit Cameron with the degree of foresight which would have been required to anticipate the growing public debt problem.

In Birmingham’s case, we didn’t have to wait for the inevitable calls for central government to ride to the rescue, because local MP Preet Kaur Gill had already called for this back in July.  But one indicator of why this might be more difficult than it sounds occurred in the hour following the Birmingham Section 114 notice being announced, when the UK gilt yields rose in anticipation of further un-backed government borrowing.

When you are dealing with a body which has an annual income of £1,017bn, it is all too easy to assume that money isn’t an object.  Of course, central government could find the money to bail out Birmingham… and Woking… and Croydon… and all of the other profligate local authorities.  And to some extent, this is correct.  Public spending is always political, and governments have the ability to make cuts somewhere else.  But few of those asking government to bail out councils are prepared to say what should be cut instead.  And so, the implicit call is for some combination of increased taxes and even more borrowing.

So here’s the problem.  International finance – institutions and individuals – are already baulking at making further loans to the UK government because, quite reasonably, they doubt the ability of future taxpayers to repay the debt.  We got a taste of what investor flight might look like when Dagenham Liz and Kami-Kwasi Kwarteng attempted to make billions of pounds in unfunded tax cuts last year.  And this was before the Bank of England decided that generating a massive national mortgage debt-default would be a good idea.

With a recession now inevitable, and with the likelihood of a 1980s-style deep depression looming, not only is the UK government unlikely to be able to raise the fabled “taxes on the rich” (which the rich – because they can afford the best tax lawyers – always manage to avoid) but it will struggle to maintain its main tax streams:

  • Income tax – £249bn
  • National Insurance – £178bn
  • VAT – £160bn
  • Corporation tax – £83bn

All of these, along with smaller streams such as fuel duty and business rates, are highly vulnerable in a depressed economy, where businesses are closing, and unemployment is rising.  At the same time, increased demand for very basic state spending on pensions, unemployment benefits, and housing support will be increasing.  So that, again, local and central government spending will inevitably be subject to much greater public scrutiny.

The adherents of Modern Monetary Theory (MMT) will – technically correctly – point out that this situation is a consequence of the fiat currency system which western states have been using since Nixon ended the Bretton Woods system in August 1971.  Just as a local council cannot go bankrupt, so a sovereign state which issues its own currency is free to simply print its way out of debt.  Indeed, since a large part of Britain’s debt is held by the Bank of England, it is effectively owed to itself and so can be written off.

This sounds plausible in a closed economy, since so long as the tax coming out of the economy is equal to the currency being printed in, there is no danger of inflation or deflation.  But with the exception of North Korea (which is about as closed an economy as there is) economies are open to trade flows across the planet.  And while an exporting state might be able to get away with currency printing without endangering its stock and flow of foreign currency (mainly US dollars) the same is not true for importing states… of which, the UK is among the most dependent – for example, deriving 60 percent of our calories and 20 percent of our electricity from other countries.

Both borrowing and currency printing in the UK, then, risk massive import inflation, as the interest rate and/or exchange rate rises accordingly.  Only the price of goods and services produced solely within the UK would remain affordable.  And even this is deceptive because a large part of what appears to be domestic production depends upon imported components, resources, and energy.  Whichever way you cut it, this would ultimately deepen the coming depression, making the state’s ability to manage its debts ever harder.

This is why it is a death-spiral.  There is no escape because, even cutting state spending adds to the loss of state income and the increase in liabilities (unemployment, pensions, etc.) which are already impacting local government.  Note, that it makes no difference which political party happens to be nominally in charge.  Because the deeper the death spiral goes, the more the material (thermodynamic) economy will hold sway over the puny interventions of people.

If it were possible to reach a consensus about why this is happening (it isn’t) we might be able to debate and agree upon a means of restructuring which doesn’t end in political extremism, violence, and social fragmentation (we won’t).  But absent the discovery of a new energy-dense source of surplus energy, Britain is set to go the way of every other failed oil state… just with a bigger bang.

As you made it to the end…

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