Monthly Archives: April 2014

Stand by for the next UK crash! ETA 2016

Even though the economic policies of the US and UK have been markedly different, there has recently been fair bit of talk on both sides of the Atlantic about how cuts in Govt spending have started to work and budget deficits have started to fall. But budget deficits do always rise sharply after a crash and fall afterwards. So are governments just trying to take credit for what would have happened anyway? Surely not!

Spending and taxation are largely still considered in isolation which is just bad economics.  For example one Conservative MP * recently claimed the collection of an “£100bn a year of extra tax revenue, compared to an increase of £66bn in current public spending”. There is no recognition of how  an increase of £66bn works. If it were spent on wages and salaries about a third would come back straightaway in taxes and nearly all the rest would quickly follow in a matter of months. Given that this extra £66bn creates extra economic activity, taking workers off the dole queue, then it is quite likely the government at least breaks even.

We have also seen claims that the “state deficit will have decreased by 40%” by the time of the next election and that “house prices will be up on average by 16% over the five years” . If house prices were rising because of increased personal income that could be argued to be a good thing but this is not the case at all. Incomes are still failing to keep pace with inflation. The UK economy looks to be in a sad state:

Labour Chart

House prices are rising because banks have started to lend again into the housing market. As interest rates are currently ultra-low, much bigger loans can be
taken out than would have been possible previously and so are forcing up prices.

It is generally known that credit bubbles are a bad thing and when they burst a recession is likely to follow. But exactly why is this the case? The best explanation you’ll get from even the BBC, who should really know better, is that a hangover usually follows in the aftermath of a party. Surely we can do slightly better than that!

The mainstream don’t at all make the connection between increased bank lending and the reduction we see in government deficits. But they should. When banks lend they create new money. It is often said they “create money out of thin air”.  That’s what banks do. They don’t take in money from depositors and lend it out to borrowers. That’s a myth. They create their own IOUs, or their own new money, and therefore increase the money supply.

This new money when spent, and respent, attracts the usual government taxes: Income tax, VAT, Corporation tax, National Insurance contributions etc etc. After its been spent and re-spent a few times there is hardly anything left in the active economy. Nearly all of it, except for perhaps some 10% or so, which is saved or spent on net imports, has gone back to government. So naturally the deficit falls! It is really little to do with any cuts in spending or increases in taxation. That spending too would have quickly returned to government in taxes in exactly the same way except it wouldn’t have left the private sector in debt.

Of course when the banks stop lending, as they always will when they start to get nervous that asset prices are getting too high, thus causing them to fall back, the amount of money available in the economy to be spent falls. Taxation receipts fall. Workers lose their jobs and apply for welfare payments. The  government deficit shoots up again.  That’s where we were just after the 2008 crash and may well be again after the 2015 election. Politicians then want to make more cuts in spending and raise more taxes to try to reduce the deficit. The recession deepens.

But, eventually the banks will start lending again, as they do, and so incorrect economic policies do appear to have a positive effect. That’s where we are now.

Tory governments are particularly susceptible to falling into the trap of creating this boom -bust cycle. We’ve seen it before under Chancellors Barber and Lawson. Even the Chinese have recently fallen prey to the idea that cheap credit can permanently boost their economic growth. They will be in just as much trouble as anyone soon, unless they realise what’s been driving their incredible growth in recent years and act now, before it is too late. Encouraging private sector lending seemingly offers a quick fix to the economy by letting the commercial banks create new money, so keeping it off the Governments books and off  the Budget deficit,  rather than directly spending it into the economy in the way Keynes or Lerner would have advocated.

It has a similar economic effect to a Keynesian stimulus for a few years but no longer than that.  It is not the right way to run the economy!

* http://johnredwoodsdiary.com/2014/04/25/capital-gains-tax-revenue-down-total-revenue-up-by-almost-100bn-a-year-under-the-coalition-to-pay-for-extra-spending/

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Muddled Thinking Watch #5: “Increase taxes to balance the budget, the revenue well is not dry” Greg Jericho. The Guardian.

http://www.theguardian.com/business/grogonomics/2014/apr/08/increase-taxes-to-balance-the-budget-the-revenue-well-is-not-dry

With government expenditure set to jump, we need to think about how to pay for it”

It’s not always the neo-liberals who get it wrong. Greg Jericho understands full well that austerity economics is bad news for the economy generally, and has previously written:

http://www.theguardian.com/business/grogonomics/2014/feb/27/australia-needs-austerity-like-hole-head

The point that Greg seems not to comprehend is that an argument for balanced budgets, in an importing nation like Australia, is also an argument for austerity economics. It would perhaps be just about possible to argue that if the budget were balanced by the imposition of a wealth tax and other high taxes on the high earners and wealthy then the degree of austerity would be slight but no, Greg Jericho makes statements like:

” I’ve been making the case that the budget isn’t just about cutting expenditure, it’s also about raising revenue.”

Greg might want to think about making the case that the budget should be about neither. It should be primarily about ensuring that the Australian economy is working close to its maximum capacity, and that everyone who wants a job is able to find one,  but without generating too much inflation in the process. That’s the economics. Greg also might want to consider if the collection of a pile of its own IOUs through the taxation system can actually be considered Government “revenue”.

In any case if  government expenditure does jump that will nearly all come back as a tax take or be saved in bank accounts. The only possible danger is inflation. Nothing else. That looks a very remote prospect at present.

There is the secondary consideration of the social effect of how taxes are levied and spending is conducted. If we want people to consume less alcohol for example then we tax it more. If we want to reduce the income and wealth differences in society we have a greater degree of graduated tax on incomes, a lesser dependence on regressive taxes like GST, and possibly add in a wealth tax too.  We spend more on public education and the public health sector and remove any tax loopholes, or anomalies,  which allow the private sector to benefit. Conversely, if we want to bring about a greater degree of inequality, we do the opposite. These are political questions.

It is important to separate the economics from the politics. IMO.  Or at least try to!

 

The EU: Progressive or Reactionary?

The French seem to be in trouble again over their 4.5% budget deficit.

https://mninews.marketnews.com/index.php/france-face-tough-talks-brussels-over-budget-deficit?q=content/france-face-tough-talks-brussels-over-budget-deficit

Unemployment is 11% and rising in France. Unemployment among their under 25 year olds is 25%, so why is the EU fussing about its budget deficit? For some strange reason the EU-powers-that-be have decreed that 3% is the limit and no more.

The economics isn’t that difficult. If everyone spends what they earn, that includes all profits, and exports are equal to imports, in the same economy in which it is earned in then everything clears. If 3% (GDP) of those earnings is (net) spent on imports then that shortfall has to be made up by government running a deficit for everything to clear.

Similarly if 5% of GDP is saved then government needs to borrow that from the savers and spend it back in to the economy too. Both the trade balance and the level of savings are outside of government control, especially for a country within the EU using the Euro.

So, 3% + 5%  (These are the figures which are much closer to reality for an economy like France) = 8%. This is the minimum deficit the government needs to run to stop the economy spiralling into depression.

So for the rulers of the  EU, or the Troika, to impose a 3% GDP limit on government deficits within the EU is criminally insane.  They understand all this very well! They understand that France cannot impose trade restrictions. They understand the French government can’t stop the population saving and they understand that’s what people do when the economic future looks bleak.

The EU powers-that-be have been smart enough, in many European countries, to seduce the centre-left into thinking that the EU is both progressive and democratic. That joining in the EU wholeheartedly is an easier option than taking on reactionary forces directly in their home countries.

Well it isn’t.  The EU reactionaries are just as bad, if not worse. It’s not just me saying that. It is the 25% + figures for unemployment in Spain and Greece, and high unemployment figures everywhere in the Eurozone  which is the real evidence for the truth of that. No amount of social legislation on conditions at work can compensate for not having a decent well paying job.

Want to make your business card worth something? Easy. Start a protection racket!

An interesting experiment is take out a bank note from your wallet or purse and ask your friends and family , “Why does this piece of paper have value?” You’ll get a range of answers. Some people may think “gold”. They will be completely wrong. There was a time when they would have been right. Once you could demand a fixed weight in gold in exchange for a pound or a dollar, but those days are long gone. Some may say “ Because you can buy things with it” — an answer that only begs the question! “Faith” will be another possible answer. Everyone will accept it because everyone else will!

There is the “because it is legal tender” argument. But, do we all do what we are supposed to purely because the law may require it? Do drug dealers happily accept cash, in dollars or pounds, for their wares because they are concerned to comply with legal requirements?

There must be another reason.

Suppose I wanted to establish my own currency. I’d start with a collection of business cards or even old Christmas cards, and write on the back of each one, 1 Martin, 5 Martins , 10 Martins etc. How would I ensure they were worth anything?. I could promise everyone that each ‘Martin’ would be redeemable for $1 or £1. If I was sufficiently well regarded in the neighbourhood then that would work, up to a point. That’s exactly what some countries do. They peg their currencies to another currency, usually the US$ or the Euro. These currencies work on the basis of an IOU.  However, if confidence is insufficient in the ability of that country to maintain the peg then speculators move in to try to make a killing by forcing its value down. It can be a dangerous game to play as many countries have found to their cost. If I can’t redeem the IOU at what I promise then technically I’m in default.

So what else could I do? Legally not much. But, if I were unscrupulously, not to say criminally, inclined, I could start a protection racket. I’d tell all my neighbours there was a problem with gangs of hooligans who came into the area at night to break windows and damage cars etc. I’d offer to protect everyone but the cost would be a signed business card of 5 Martins or however much I considered each person and household could afford. They would want to know how to acquire my signed business cards and I’d suggest they could paint my house, mow my lawn or clean my car or whatever. My signed business cards would acquire a value to me. I’d get work done for nothing! People from out of the area, who weren’t covered by any offer of protection would also work for me to acquire the Martins and either sell them to those who were in need of protection, or exchange them for an agreed value of goods and services. My business cards would be just like money. I’d be have to issue just enough Martins to enable my neighbours to acquire the cards at not too great a cost but not too many that they started to lose their value!

Martins would have an exchange rate! I would naturally keep an eye on what that was and use fiscal policies to control its value. My business card would still be an IOU but this time it would be a much vaguer IOU. There would be no guarantee that a ‘Martin’ would be worth anything other than 10% of 10 Martins.

Whereas everyone else would think of Martins as money, to me, as an issuer they would be useful but I wouldn’t view them in the same light as users of Martins. There would be no point in saving them up, for example, just in case I was short of them at some time in the future. I’d always be in debt in the sense that I’d always have issued more Martins than get returned to me. Would I have to balance my budget and only spend, in Martins, what I received in Martins? No of course not!

If I were arrested and thrown into jail then my cards would be instantly worthless. If another racketeer took over my patch he might, to establish some form of ‘customer relationship’, offer to redeem some of them but he would not have to.

My neighbours will be pleased to know that protection racketeer isn’t exactly my choice of profession. I’m not confident I’d be able to frighten people sufficiently to keep their mouths shut!   But governments aren’t similarly constrained. They send us tax bills so we can pay for their protection from all sort of threats, both real and imagined. If we don’t pay we don’t get our windows and cars damaged but we do run the risk of being jailed! Libertarians probably like the idea that Governments run legalised protection rackets. Liberals and Socialists less so but that’s essentially the way things are. It is the power of the State which gives the $$ and ££ their value.

So whereas Bob will take a £5 note or a $5 bill in payment from Ann because Bob knows that Col will take it from him, it cannot be an infinite chain. The chain is possible because at the end of it, Zoe has a tax bill to pay. It maybe a TV licence or car registration, and she needs that £5 note to help pay it.

If a government ceases to exist, for any reason, as happened when East Germany dissolved itself in 1989, its currency becomes worthless. There’s no need to pay the protection money, sorry taxes, any longer! The new racketeers, sorry the new unified German Government, weren’t completely heartless though. They did offer to exchange Ostmarks for Deutschmarks up to a certain value!