The British Government has been on a decade-long borrowing binge. High on debt and intoxicated by power, it's not showing any signs of stopping. There is now a long-term structural imbalance between what the government spends and how much money it raises in tax. This policy of never-ending budget deficit is unsustainable. Even if the excesses don't get any worse, we're all in for a massive hangover.
Higher taxes and spending cuts
On average, British government bonds pay interest for 15 years. The more we borrow, the bigger our interest payments get. Last year national debt interest cost the taxpayer £27.2 billion. In 2010-11 that figure soars to a jaw-dropping £42.9 billion. The more we spend on interest, the less we have to pay down debt or invest for the future. That interest is dead money, which means higher taxes for years to come.
Stifling of business
Government borrowing increases the total demand for credit in the economy, driving up the cost of borrowing in the process. Higher borrowing costs make it more expensive to finance investment in equipment, stock and other capital goods in the private sector. This harms the ability of the private sector to create the wealth and jobs needed to get us out of recession.
To make matters worse, the government needs to sell its bonds at attractive interest rates to entice investors away from alternatives. This is known as the 'crowding out' of private capital and means even less investment in business and real jobs.
High interest rates
The Government relies on investors continuing to buy UK gilts to fund its spending habit. If the bond market gets nervous about our excessive borrowing and the demand for gilts falls, their price also declines as a result. Because they now cost less to buy, gilt yields start to rise. This means we pay more in interest for every penny we borrow, suffocating our deeply unhealthy economy even further. Everything from trade finance to mortgage payments would get more expensive.
Many of our biggest customers are pension funds and foreign central banks that only invest in the safest 'Triple-A' bonds. For the time-being Britain retains its AAA status, meaning the major rating agencies believe we're still a good bet. But if we lose their seal of approval and the big investors that come with it, the consequences for our country could be devastating.
If the market for gilts weakens, we can always print money to buy our own bonds, which is what the Bank of England is already doing with its so-called Quantitative Easing programme. This gradual debauching of sterling raises the spectre of high inflation once the economy begins to recover. If investors see their holdings devalued they'll be reluctant to buy gilts and may even start to sell, sending interest rates spiraling upwards.
If we fail to get a grip on spending at that point and print even more money to cover the shortfall in gilt sales, extreme inflation and a potentially fatal sterling crisis would ensue.
On the other hand, we may find ourselves in trouble much more quickly. If a gilt auction fails Britain would be plunged into a full-blown economic crisis. Overnight, we would be forced to make savage spending cuts to balance our budget, sterling would plummet and we'd need an IMF bailout to stave off complete bankruptcy. Economic and social breakdown could conceivably follow.