Have no doubt about it – the private sector is going to be battered by ConDem cuts – and the result will be recession

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George Osborne’s belief is that if the state sector is scaled back the private sector will rush to fill the vacuum. That's why he’s willing to impose massive and destructive cuts on the wellbeing of ordinary people in this country.

He’s wrong to think this. There are three reasons for saying so. First, as the FT reports:

The dangers facing companies that supply the UK public sector were highlighted on Friday when Connaught issued a profit warning that wiped out almost a third of the social housing maintenance group’s market capitalisation.

The FTSE 250 company became the first big state contractor to warn that the looming spending cuts in the wake of George Osborne’s emergency Budget would materially hit earnings this year and next.

Have no doubt, these companies will not be alone.

Second, there is no reason why the private sector could not take up the slack now. Again, as the FT has reported, admittedly with regard to US companies but with the scenario being replicated here in the UK:

US companies are signalling a desire to buy back their own shares at the highest rate in months as record levels of cash pile up on balance sheets.

So far in 2010 there have been 343 new authorisations for $178bn in buy-backs, according to Bank of America Merrill Lynch. If carried out, and projected over a full year, it would be the highest volume since 2007, or $898bn. Last year, there were only $128bn-worth of buy-backs. Other US companies announcing $1bn-plus buy-backs in June were CVS Caremark, Viacom and Monsanto.

This situation of companies being very heavily cash rich right now is common: it’s happening here in the UK too. Again as the FT reports (same link) there is an excuse:

Companies so far in 2010 have been cautiously exercising their right to buy shares. They are keen to maintain a large cushion, as rating agencies are closely watching cash balances as credit markets tighten.

So the rating agencies which stop government borrowings are now also the people stopping companies spending to make up the gap! The madness of the impact of these wholly inadequate organisations continues.

But there is a third reason why the private sector will not be filling the gap. It’s not just that the government is not spending, and they’re the biggest single customer for the private sector. Nor is it just that household well being is collapsing – although it is. The real reason is much more important and never stated: the simple, fact is that there’s nothing the private sector can sell to people that can make up for the loss of the state services they really want right now.

People want schools.

people want law and order.

People want well maintained roads.

People want social services.

People want the safety net the state provides.

People want fair pensions – not ones that decline in value.

People want to know they won’t be financially devastated by sickness.

And they’re being denied these things. In the face of that reality they’re not going to go out and buy new goods or indeed new services. There are only so many televisions they need. So many phones. So many clothes. And so on. But they don’t want them, as much as the security the state supplies.

So they won’t substitute reduced state spending with more private spending. They’ll hoard cash – just as companies are – because it is vital for them that they build up their own reserves to cover the risks that the state has until now insured them against. The consequence of that is obvious. We will have a profound and deep recession , if not depression.

All of that for reason of dogma: a wholly false belief that the private sector is crowding out the private sector when people actually want what the state is providing more, I suspect, than any private sector alternative. And one other illusion – the one that creating “sound money” of constant value is worth this pain. It isn’t. Planned inflation has to be part of the solution too. It is the only historically proven way to wash bad debt out of an economy. Which is why we need it at 4 to 5% now.

These dogmatic illusions – by the Conservatives and as much by Orange Book Lib Dems will cost us dear. We will pay an enormous price for them. One day they will too.