UK needs to be careful it doesn't end up like Iceland

Nov 27 2008 By Neville Boyd Maunsell

Alistair Darling is set to borrow the mind-numbing sum of £118billion next year – providing that his Treasury forecasters have not grossly under-estimated the strain on the public finances as they have done every year for a decade. Chances are that he will need more, as his tax receipts dry up.

No doubt our chancellor takes it for granted that he will get the money, tolerably cheaply, too.

Interest rates are crashing round the world as central banks do their bit to ward off the recession. Inflation that has made conventional government bonds a rotten long-term investment, is yesterday’s menace.

Today’s bogey, deflation, only adds to their attraction.

Above all, British government bonds are the ultimate safe haven in troubled times – that is why they are called “gilt-edged”. Yet on Tuesday, the day after Mr Darling’s Pre-Budget, the cost of insuring against the British government defaulting on its debts suddenly rocketed.

Someone out there was thinking the unthinkable. If Iceland can go bust, is Britain right off the radar?

The Treasury was understandably dismissive, pointing out, that British governments don’t default. They never have since they started piling up the national debt in 1694.

Well, that depends what you mean by default. Birmingham’s last chancellor of the exchequer was Neville Chamberlain.

He did the job for six gruelling years in the 1930s and won so much respect that he became Prime Minister – a less happy story.

Chamberlain’s first task was to tackle the daunting debt left over from World War I. Patriotic savers had subscribed more than £2billion to War Loan – very serious money at the time. It was an undated gilt, with no promise to repay. But investors received a generous five per cent.

That was too generous for cash-strapped chancellor Chamberlain in 1932. He cut the coupon to 3.5 per cent, where it has remained ever since. War Loan holders who didn’t like that could have their cash back, he said.

There was no need to spell out that if many of them did, the government could not possibly find the money.

It would have to print it outright and inflate away the value of all its debt – as happened in double digit-inflation of the 70s and 80s.

Chamberlain’s cut was applauded as a stroke of ruthless genius, not a default, oh no. That way, you can trust chancellor Darling and his successors not to default either.