Economics - part 1

This is a post (series of posts!) inspired by my brother who liked my description of how the finance system operates and thought I should publish it. Trouble is, I know a lot of stuff but don't know how to put it all together coherently. A bit like the government! But, here goes.

This will encompass government debt, pensions and the stock market. It might touch on the housing market and personal debt or savings, and it might mention the Euro crisis. Or it might not.

A long time ago (60s/70s) public finances were all about the Balance of Payments. That was (if you are too young to remember) the difference between what we bought from abroad and what we sold abroad, i.e. (Exports) - (Imports). The impact of a BofP problem was that inflation went up and the value of the pound went down. Both made people poorer. The proposed solution was to Buy British and avoid imports. However, that went against free trade and especially after we joined the EEC (as it was then) European procurement rules. If we Bought British no-one else would and exports would collapse. Another principle was required. (aside - the BofP even in those days was always negative in real terms - physical goods - but overall positive due to the impact of "invisibles" i.e. financial services)

After Thatcher arrived the Big Thing (apart from a Property Owning Democracy) was Money Supply. Think of inflation as caused by too much money (demand) chasing too few products (supply). Cutting the money supply reduces demand and so cuts inflation. (It also makes struggling businesses bankrupt and people unemployed). The theory was that once the unfit, unprofitable businesses that relied on easy money were out of the way the remaining economy would surge forward unfettered by inflation and high interest rates. Mostly what surged forward unfettered was Financial Services.

At the end of the 18 year Conservative hold on power New Labour inherited a strong economy with low and reducing inflation and buoyant tax receipts. They decided to continue with Conservative spending and tax plans for a few years - a good move at the time. Later, however, Gordon Brown invented the idea of balancing the budget over the economic cycle. That means borrowing in lean times to support services and paying back in good times from enhanced tax revenues. Unfortunately Gordon couldn't see a cycle when it was staring him in the face. He declared a palpable boom was in fact a recession and borrowed to fund increased service expenditure (I won't say increased services, he just spent more on what we already had). He also deregulated Financial Services. At the end of the Labour term a thoroughly de-regulated financial crash forced huge further borrowing to bail out the banks and also slashed tax revenues and increased welfare costs. Result: massive debts and a massive deficit adding to them every day. No, Ed (Balls/Milliband), Labour didn't cause the global financial crisis, they just removed the regulations that might have prevented it and put the UK economy is a uniquely bad position to weather it.

This combination of high debt and high deficit is significant, and both main parties recognise that. The deficit means we have to borrow more money to fund daily government expenditure, a significant proportion of which is paying interest on the debt. You can see where this is going, especially if the financial markets got the idea the government might not be able to pay back that debt and so increased interest rates. (Aside: the  Bank of England claim to set interest rates, currently 0.5%. That is the rate at which the bank will nominally lend money and tends to detemine other lenders' rates in the domestic market. However, that is not the rate at which the government borrows money. That rate is set by the financial markets in bond auctions and is a lot higher). If interest rates rise, the deficit rises and cuts must be deeper.

Cut to Greece. The Greeks don't want the austerity measures being forced on them by the EU and IMF in return for "bail-out" loans. The reason the Greeks need those loans is that no-one else will lend them money, but they must borrow to finance their expenditure. Had the proposed referendum gone ahead, the choice would have been between cutting expenditure under EU rules or cutting expenditure because the government had no money and no-one would lend it to them. The former at least promised a stable future, the latter could have ended in penury for everyone.

More in part 2 (and 3 and 4)