My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 Issues by Peter J Underwood, author
As an introduction to government finances we looked at a general overview of sovereign debt with its relationship to GDP and the global financial crisis of 2008; here is the link to last week: Issue 23
In this Issue we will consider the economics of government finances leading on from Hank Paulson’s ideas on what should be done to manage sovereign debt effectively. There’s no doubt that governments today are under extreme pressure, especially in the emerging economies, where they have gorged on debt over the last 10 years and are now vulnerable to exposure in dollar denominated debt as the dollar strengthens and impacts debt repayment.
CHAPTER 5
GOVERNMENT FINANCES
“Government is not reason, it is not eloquence – it is a force! Like fire, it is a dangerous servant and a fearful master; never for a moment should it be left to irresponsible action.”
George Washington
The economics of sovereign debt management
Hank Paulson’s sentiment echoes the ideas of economist Henry Morgenthau, Jr. (1891-1967) the U.S. Secretary of the Treasury during the administration of Franklin D. Roosevelt. Morgenthau believed in balanced budgets, stable currency, reduction of the national debt, and the need for more private investment.
On November 10, 1937, Morgenthau gave a speech to the Academy of Political Science at New York’s Hotel Astor, in which he noted that the Depression had required deficit spending, but that the government needed to cut spending to revive the economy. In his speech, he said:
“We want to see private business expand. … We believe that one of the most important ways of achieving these ends at this time is to continue progress toward a balance of the federal budget.”
I fully support Morgenthau’s propositions which I believe are as relevant today as they were 76 years ago. If a leader of Hank Paulson’s stature can reach similar dramatic conclusions, someone who is at the heart of the problem, then one expects that changes would have been made by now.
Sadly this is not the case, and I am sure Hank Paulson will be the first to agree that the measures taken so far fall significantly short of any remedy sufficient to avoid a repeat banking or sovereign debt crisis (government debt crisis); even both simultaneously occurring in the future.
In fact we have already had the “Cyprus” event in 2013, which, as a test case, has to be a portent of things to come. The significance of these acts is that the Fed and the governments are fully aware of the disaster that’s coming and they have taken conscious action, not to lessen the damage to the economy, but to bail them out when the collapse comes.
From the outside looking in I can only despair at the impotence exercised by our governments. Their excessive spending habits, driven by puerile political motives, leave the general populace to wallow in ‘austerity’ while those connected or close to the financial apparatus party on.
It is apparent that what politicians claim they can do in no way meets the reality of their mandate to prudently manage public debt. They have devolved their responsibilities to the barons of finance who now undertake to monitor and control those systems to which end they have failed miserably.
As Hank Paulson intimates, the solution must be a complete rewrite of financial systems from top to bottom, in the meantime we can only look forward to more of the same until the next generation hopefully rises to the occasion. As it is now, we can only look at how government finance functions today, and I trust that the reader will be able to stifle a cynical guffaw whilst reading on.
The functioning of government finance
‘Public finance’ is one of those subjects which we would all chose to avoid when given a choice. Unfortunately, in today’s world we have no option but at least to gain some working knowledge of finance, if only to become competent at managing our own affairs, and know how to use this broken system which will give us an advantage when planning our own futures.
I suggest that the government’s main job, in peacetime at least, is to promote the economic wellbeing of the country and effectively manage its finances and welfare. To do this properly it needs to fund its projects by raising taxes, on a fair and equitable basis, and disbursing these taxes throughout the economy to the benefit of improved environment, health, education, enterprise, defence and many other worthy causes.
However, in spite of all the taxes collected during a year, they are nowhere near enough to fund all the projects and match the aspirations of rapacious political elites. Therefore, it is argued, the government must ‘borrow’ the money they need; the mechanism for this was described in the last Chapter.
What is now of interest is how much should the established authorities borrow in order to maintain a stable and orderly society? This is the question we answered with balanced budgets; but of course, the ‘powers-that-be’ do not subscribe to ‘balancing their books’ and continue merrily spending, beyond all reasonable limits, and promoting their prescriptions through their captured media: the national press and TV.
Regardless of the current debate in the world of economics I believe Reinhart and Rogoff are right. What all the studies have shown is that when the ratio Debt to GDP rises between 90-100% it damages economic growth. However, when debt to GDP rises above 100% negative returns occur (Phillip Rother and Christina Checherita).
There are connections between changes in government debt and economic growth rates in the following areas:
- Private Saving levels
- Amount of Public Investment
- Factor Productivity Growth*
- Long term nominal and real interest rates.
*In economics, total-factor productivity (TFP), also called multi-factor productivity, is a variable which accounts for effects in total output not caused by traditionally measured inputs. If all inputs are accounted for, then total factor productivity (TFP) can be taken as a measure of an economy’s long-term technological change or technological dynamism
It is clear, from all of the available evidence that higher public debt levels are leading to weaker economic growth. In past examples there has also been a negative impact on output when private sector debt rises above 160%. This is why in USA 260% (100% of Federal debt to GDP plus 160% of private debt to GDP) of total debt is the level at which the economy eventually experiences negative growth.
The problem, longer term, is that extreme over-indebtedness has historically led to higher inflation in developed economies. It is one thing when one country is over indebted because there have always been other countries to bail them out. It is quite a different story when virtually every economy on the globe is over-indebted, to some degree or another, as a result of the flawed global financial system.
Government borrowings and markets
Financial and other markets are not currently reflecting the reality of poor economic growth worldwide. Stock market prices are back to levels reached before the crisis and bond yields are artificially low due to QE; so much so that the result is a negative return after taking into account inflation albeit at a low level for the present.
Despite QE creating massive amounts of free money to flow into commodity prices, markets have actually seen a fall of some 20% from four years ago. There is no sign of significant inflation; more a period of deflation (lower prices and lower real wages) which appears to be baked into the global cake (the phenomenon of ‘inflation’ and its consequences will be examined in later Issues).
As we have seen, GDP is a key measure of a nation’s total income against which government debt is measured and is the market value of all final goods and services produced within a country in a given period of time, usually a year, which for Britain amounts to some USD2.9Tn (reference: Trading Economics).
In addition, ‘GDP per capita’ is a measure of a country’s standard of living and equates to the total population number divided into GDP). Britain is one of the most indebted nations on earth but has a high standard of living. In round sums, the H.M.Government (HMG) public sector borrowing requirement (PSBR) is running at the rate of around £50Bn per year (even after the 2013 austerity measures!) and is a measure of how much HMG is over-spending. For example: HMG total income for 2011/12 is around £600Bn and total expenditure came out at £720Bn. Therefore the total year’s deficit, which has to be financed by borrowing, was £120Bn.
At the end of 2015 the national debt totalled some £1.56Tn, approximately 90% of total GDP, although in 2002 it was only 29% when annual borrowing was relatively small at £20Bn. HMG has to pay interest on this debt to the holders of government bonds (gilts), for example: pension funds, and which represents all the IOUs outstanding issued by government. In 2012 the interest on this debt amounted to some £43Bn, which has to be paid from taxation, and represents almost 3% of GDP.
The UK national debt is large in relation to the economy and growing rapidly; it is owed to a variety of investors and financial institutions as well as some 35% being owed to overseas governments and investors. This is the most risky part of the debt because foreign investors are fickle and can choose to sell their UK bonds in the market and cause a run on the bond markets which can quickly result in higher interest rates and greater inflation.
Since 2008, when the British economy slowed sharply and fell into recession, the national debt has risen dramatically, mainly caused by increased spending on welfare benefits, bank bailouts, and a significant drop in receipts from taxation due to poor economic performance.
To be continued next Saturday
Like most everything being written here these days, it’s just a mountain of words strutting on the Public Stage meaning nothing; since the government starting printing money out the ass to buy all the securities being sold by our Treasury, China and Russia etc, all the rules of Economics went into the toilet and that is where the dollar will soon take a huge hyperinflation dump, flushing the whole US and World Economy down the drain making a giant sucking crashing sound like a tornado hurricane the world has never heard or seen or felt. All the verbose experts will become worthless too.
There is no logical reason for a sovereign nation to borrow it’s own currency. Government debt is a relic of the past, one invented by the financial oligarchs of the early 20th century for the sole purpose of assuring the creation of money would remain in the hands of the financial elites… and not subject to review by citizens. A hundred years of this nonsense has driven a great ideology into the ground, and made the average American citizen dumber than a box of rocks. There is no better example than that woman in the east who calls herself a socialist ; with every phrase she speaks she reveals the mind of a child. This nation is quivering on the brink of a great national travail.
It will not end well.