The problems faced by the UK are fairly typical of what is being experienced elsewhere. Fundamentally, there is too much debt and not enough growth. UK Government borrowing remains at historically high levels and will not return to normality for five years. Even this outcome depends on continued spending cuts and faster economic growth. The UK is in it for the long haul.
We are experiencing a period of financial repression, one where interest rates are held below inflation for a sustained period. This eases the pressure on those who are in debt and ensures that the Government can issue its own debt at lower yields than would normally be the case.
For many investors, repression is of course boosting the value of their investments, but for others, there is a heavy price to pay.
But is there an alternative approach?
The UK Government has four other ways it could go.
Austerity
It could embark on a policy of real austerity, along the lines of what happened in Latvia, shutting down chunks of its activities in an effort to balance the books.
Such a "shock therapy" policy would trigger a major recession but may lead to faster growth in the longer term. This would be hugely risky and divisive.
Default
Perhaps the Government could simply default on part of its debts, as part of a globally co-ordinated move to reduce the level of sovereign debts. Inconceivable, surely.
Inflation
Or what about a dose of inflation, to erode the real value of the debt? To an extent, this is already happening, but again, it is inconceivable that the Bank of England would countenance a return to 1970s-style inflation, with its inevitable impact on living standards.
Growth
Finally, the Government could go all out for economic growth, whether through more demand-side spending (thus gambling that the markets will accept a higher short-term deficit) or through such supply-side measures as changes to incentives, labour laws and business regulation.
To a limited extent, this is happening already, but there is much more that could be done, and confidence is still low.
The markets are right to be worried about the economic prospects in the UK and elsewhere. As Keynes wrote in his 1936 book The General Theory of Employment, Interest and Money: "If the animal spirits are dimmed and the spontaneous optimism falters...enterprise will fade and die."
In these much-talked of animal spirits lies the best hope for recovery and escape from repression.
Here, equity markets have an important role. Shares have delivered remarkable returns since their low point four years ago. Yes, part of the gain can be attributed to central bank support, but even so, robust equity markets are good for confidence.
Rising share prices trigger corporate activity, as business people want to invest, believing that markets are telling them that better times lie ahead. Buoyant markets also boost consumer spending, which combined with rising business investment provides a welcome boost to profits, and hence to share prices – and thus, a virtuous circle sets in.
Fanciful? Perhaps.
However, equities are often a leading indicator of how an economy is going to perform. Valuations remain supportive and equities are still an attractive asset class, not least from an income perspective.
Further gains could help the UK and other economies escape from their current troubles faster than some of the forecasters expect. Otherwise, financial repression may be with us for a very long time.
Harry Morgan is head of Private Investment Management at Thomas Miller Investment. The views expressed here are his own.
