Friday, 21 November 2008

Spending our way into trouble

Over the weekend, Alistair Darling will be putting the finishing touches to his pre-budget report. Judging by the pre-statement leaks, Darling is going to cut taxes, increase spending and make up the difference with a large does of financial irresponsibility.

We all know, deep down, that it won't work. Afterall, does anyone remember the Bush stimulus package from this year? In the second quarter, the Federal government mailed out cheques amounting to $160 billion; three months later, the economy shrank and unemployment hit a 16 year high.

Pointing to transatlantic failures never deterred a British politician from doing something stupid. Critics of the upcoming spendathon need to develop a more coherent critique. In particular, we need to hammer home one basic point; every fiscal stimulus needs to be paid for. There are only two ways a government can do that; print money or borrow.

If the government doesn't have the money, the Bank of England can print it for them

Governments don't always have to raise taxes. It can get the central bank to make money. All it needs is a printing press, a few tonnes of paper, and a comforting picture of her majesty.

Rather going straight into the inflationary conquences of such a patently erroneous idea, lets take a more european route and start by asking a seemingly daft question? Hands up anyone you thinks the UK is in the European Monetary Union. What, no hands? Wake up, people; the UK is in EMU, it simply hasn't adopted the euro.

What has this got to do with the BoE helping out by printing up a few quick fifties and handing them over the the capable hands of Brown and Darling? Well, membership of the EMU prohibits central bank credit to the government. That means that the Bank of England can not legally crank up the printing presses. Brussels won't allow it.

The reason for this should be obvious. The ECB, being a supranational central bank can not give credit to individual member state governments. If the ECB can't do it, then why should the BoE be allowed.

In any event, everyone knows that printing lots of money creates lots of inflation. Just ask any Zimbabwean, who always seem to have an impressive understanding of monetary economics. This is why the EMU prohibition on credit to the government is such a wonderful thing. It almost makes EU membership worthwhile.

Borrow now, pay later

The greatest lie ever invented in modern economics was the one that said that the government budget does not work like a family budget. The idea is that governments can borrow from "within the family" and use the money to boost expenditure when times are rough. On the contrary, government finances are exactly like those of a family. If the father borrows, the children pay.

Take Italy as a grim example; in the 1970s, successive governments bought off an aggressive union movement and stroppy public sector workers with huge government deficits. The public sector debt stock exploded, reaching over 100 percent of GDP. A sorry procession of Italian governments tried to push the problem into the future with more borrowing. However, creditors had little patience with Italian debt, as soon as they saw more of it emerging from the Italian Treasury, they demanded higher interest rates.

Those high spending 1970s left Italy in a semi-permanent fiscal crisis. The debt stock remains high, the government pays out several percentage points in interest payments, leaving the whole sorry mess to the next generation of taxpayers.

Prudence, where did you go?

I do wish she would would return; I always liked her.

Governments should set the tone for the rest of the economy. Sound financial management; low tax levels, zero debt levels, and no deficits - that is the magic recipe. If the government behaves itself, then the private sector will follow.

Likewise, the Bank of England should keep monetary growth under control; and never extend credit to jokers like Brown. For its part, the Financial Services Agency should keep the banks on a tight leash, because they will misbehave if you let them.

Above all, get the basics right; and leave the private sector alone to look after itself.


Electro-Kevin said...

Big Government = Big Spend

Brown's not interested in any other equation

Nick von Mises said...

It's really simple. They tax people who won't vote for them, and give the proceeds to the people who do.

They also know that the Labour voter base is mentally challenged and can't process simple maths.

Anonymous said...

The most interesting point I read this year.
The UK government cannot monetise debt because of our connection to the Euro area.
An amazing point. So we never were out of it.

roym said...

given where we are TODAY what should be done to try and avoid 2 million + unemployed and hundreds of firms bust?

hatfield girl said...

Dunno why people are always having a go at Italian finances. You need a different way of thinking about economic data when thinking about Italy. Most of the wealth producing in Italy isn't visible officially to the government. Lots of other differences too, but the proof of the pudding is in the eating. We are rich, well educated, and don't have Gordon Brown as prime minister. Berlusconi is a crook but so are we all, so that's all right. The English should be so lucky as to have an Italian standard of living.

Anonymous said...

Alice, have you read Nick Clegg's take on the subject?

The language he uses could just as easily be attributed to Brown except that Clegg feels the need to use the word 'green' in every sentence in an attempt to set his party aside from the others.


Anonymous said...

In a speech by a memberof the MPC (I forget which one) it was mentioned that monetising debt was outlawed under the treaty of Maastricht - no doubt a clause carefully inserted by those international bankers who stand to gain most!

John Pickworth said...

Above all, get the basics right; and leave the private sector alone to look after itself.

Arrrhh the good ol' days ;-)

I wonder if we'll ever see them again?

Anonymous said...

Nick: Agreed, most definitely. Fiscal stimulus will only delay temporarily the necessary decline in wage costs to make the UK competitive again. Taxes to pay insufficiently productive workers. Silly.

Alice: Thanks, very insightful as always.

Please God don't let them just print money and take the economy to hell in a handcart that way.

B. in C.

paul said...

Hi Alice,

I'm hoping it won't get as bad as Zimbabwe, I'm still trying to adjust to prices staying the same from week to week after being in the UK for two years now and I've missed the worst of the Zimbabwean experiance. But if it gets that bad I have a friend who stayed on to become an expert in hyperinflationary survival who will be happy to advise businesses and individuals for a fee.

Find your blog quite thought provoking and informative, I just wish I could do something but unfortunately I'm stuck here with Uk debt and don't really want to go back to Zimbabwe right now anyway.


Anonymous said...

"The UK government cannot monetise debt because of our connection to the Euro area."
If the B of E does monetise, who's to know ? Is there any way to find out ?
This is important because you either get (hyper) inflation on the one hand or a severe deflation on the other. My bet is that the government will have to obey the law like everyone else. This means an extremely severe depression culminating in the ultimate default on Govt Bonds. Then the Pound backed by nothing becomes meaningless and the welfare state collapses. To see what could happen happen, just look at Iceland.
The only way to get money into the economy is through govt spending. The private sector has stopped borrowing and the banks no longer lend. The fiscal deficit will eventually blow out to the point where creditors refuse to lend to the govt and also demand high interest rates. Eventually a return to reality and the abandonment of the welfare state will be the only way out. Either that or it will be totalitarianism/communism.

Anonymous said...

I think your point that EMU restricts BoE funding to be incredibly important.
Are you completely sure this is binding?

Nick von Mises said...

Would the EU rule about not monetising debt happen to be written on the same piece of paper as the rules about keeping debt-to-GDP under limits and the current account deficit too?

i.e. the same piece of paper Darling is currently wiping his arse with

Alice Cook said...

Anon 18:57

Rules are made to be broken.


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Great post. I just discovered your blog. A link is on the way.

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