AAA Credit Rating – 1937 And All That

The UK finally lost its AAA, or Triple A, credit rating at the end of last week. Some have – genuinely, it seems – wondered why this should be. Others knew it was coming, an inevitability given what had already happened to the USA and France, the state of the economy, and the approach of the Coalition. To illustrate why the last-named matters, we need to go back over 75 years.

Here I am indebted to the considerable wisdom of economist and commentator J K Galbraith, and his recollection of the Depression years in the USA (the wording is from The Age Of Uncertainty, page 218 in my version). He noted:

“In 1937, recovery from the Great Depression was slowly under way; production and prices were rising, although unemployment was still appalling. The men of sound judgment now asserted themselves. They moved to cut spending, raise taxes and bring the federal budget into balance. The few Keynesians protested; our voices were drowned out in the roars of orthodox applause. As the budget moved toward balance, the recovery came to a halt. Presently, there was a new and ghastly slump, a recession within the Depression. It was entirely as Keynes predicted. The men of sound judgment had made our case”.

The lesson that Galbraith had observed being finally learned by those who had previously claimed to know better was that, whatever their adversity to running a deficit, withdrawing support for the economy while it had not yet recovered had one all too predictable result: it induced a slump.

Many pundits, especially those of that same orthodox persuasion that wreaked such havoc with the US economy in 1937, continue to tell us not to look at our own flatlining economy but to “look over there” at the deficit. But cutting spending – removing capacity from that economy – will no more benefit the out of work than bleeding a patient will boost his own recovery.

Those same pundits tell that there should be tax cuts to kick-start recovery, but the USA has had those in place from the Bush era, to little effect: there had to be a stimulus program to do that job. We were previously told that to keep running a deficit would risk our credit rating, but we’ve had the rating downgraded anyway, despite moves to close the deficit.

Today, we may not have Keynes to guide us, but we do have the advocacy of Nobel laureate Paul Krugman, who has noted that “weakness of the economy has led to lower revenues” (he meant the USA but could have been talking about the UK), and of “leaving the deficit alone for now” [my emphasis]. Krugman presses home the same point as Galbraith: balancing the budget too soon does not work.

What is worse, we know this, and yet our Government keeps blindly to its course.