Ver Are You All Coming From?

TUESDAY, NOVEMBER 16, 2010

Ver Are You All Coming From?

From Smurfland ver ve belong.

Spot the difference between these two entertainers from Belgium:

Many years ago, Mrs T took the junior Tylers and friends for a birthday treat to see the Smurfs Show. The show was bad. Very bad. In fact, it was so bad the theatre gave a full refund to the entire audience. The entire audience of about 30, that is.

The Herman van Rompuy Show is a very similar offering - amateurish, Belgian, and incomprehensible. The only difference is that there are no refunds.

There is a well rehearsed theory that the EU is the Fourth Reich in disguise. But just clock Herman's performance in the midst of the biggest EU crisis ever - he's making it up as he goes along.

The Euro is bust. The one-size-fits-all currency doesn't fit, and in one way or another it will have to be dismantled. The PIIGS will have to be cut lose and the Euro shrunk back to its Germanic core.

Even the Smurfs would have understood that.

The Real Question - Who Pays?

A seriously bum rap

Here's what's supposed to happen: you borrow some money, and then you repay it. And the emphasis is on the word "you".

Now, what's so hard about that? The practice has been around for centuries, and nobody can honestly claim ignorance of the rules.

Yet somehow, when borrowers decide they can't make their repayments, it's rarely seen as their fault. Instead, the blame is landed on the lender, either for making it too easy to borrow in the first place, or for demanding repayment in times of difficulty. Tyler has never thought it fair that poor old Shylock loses his ducats because some smart-ass amateur lawyer gets the borrower off on a technicality, especially when Shylock would still have had to honour his own debts to his depositors. But you're meant to cheer.

And so to the current Irish crisis.

The Irish have borrowed A Lot of money. Their citizens borrowed a lot to buy property, their government borrowed a lot to... ummm... spend, and their banks borrowed a lot to punt around, largely on property loans. Their external debt is now a staggering 1300% of GDP, most of it now effectively nationalised through the government formally guaranteeing its banks' debts.

Here's how it ramped up during the go-go years to reach its current €1.74trillion (chart is in millions of Euros, taken from the highly informativeIreland After NAMA):

So who's to blame?

Well, yes, the Irish of course. For borrowing so much. Obvious.

But Tyler is just listening to J Humphrys summarising the situation for BBC R4 Today: "...the vultures are circling Ireland... the country may be forced to hold out the begging bowl... the vultures may then turn their rapacious attention elsewhere..."

Those greedy flesh-ripping lenders - why does anyone put up with them?

But what's the real question beyond the tabloid emotion? The real question - as we all surely understand by now - is who's going to pay? Not just forIreland's debts, but for Greece, Portugal, Spain, Italy, etc etc.

As regular BOM readers may recall from this blog, traditionally there have only ever been four options for governments with too much debt. Let's review them to see who actually ends up paying:

1. Repayment - ie the government runs budget surpluses. Taxpayers pay.
2. Default - most likely in the form of a partial default via debt restructuring (aka haircuts, debt for equity conversions, or coupon conversions). Lenders pay.
3. Inflation tax - where debt is denominated in fixed money terms (as most is), governments can work off their debts by engineering inflation - effectively a gigantic stealth tax on debt holders. Lenders pay, including anyone who has been foolish enough to save their nest egg in a building society account.
4. Growth - GDP growth is the holy grail of indebted governments. Growth makes a given amount of debt less significant relative to GDP and tax revenues with each passing year. It's a get-out-jail free card for both the borrower and the lender.

But this is where Ireland and the others have a problem. Because they're members of the Euro, and that pretty well nukes options 3 and 4. As everyone in the real world always understood, the Euro makes it impossible for individual members to crank their own printing presses. Ireland and the others can't impose an inflation tax, and can't depreciate their currencies to stimulate growth - they're locked in.

Which means the only options are either to repay - whatever the tax and spending implications - or to default.

Now, the average Irish/Greek/Portuguese/Spanish citizen is going to opt for default - no question. But sadly, the lenders aren't nearly so keen. And since the lenders largely comprise banks based in other member states of the EU (including Britain), those members are not keen either.

Which is why Ireland and the others' membership of the Euro has brought a fifth option into play - transfer the debt to taxpayers in other countries.

And that's precisely what is being done with the EU's €750bn bail-out package, agreed during the Greek crisis in May. Taxpayers elsewhere are being forced to guarantee up to €750bn of loans to basket cases like Ireland.

Fortunately, the UK's share of these guarantees is limited, because - thank God - we aren't members of the Euro (keeping us out was one of only two useful things G Brown ever achieved). But even so, it could still be well over £10bn (including both our €8bn share of the European Financial Stabilisation Mechanism and our €4bn share of increased IMF lending).

But spare a thought for the German taxpayer. They've always run a tight Lutheran ship in terms of their own borrowing, but now they're being called upon to guarantee tens of billions of Euros in loans to the wild free spending PIIGS. And they will note that the EU's announced €750bn bail-out fund only covers a fraction of the total external debt of the PIIGS, which comes in at over €5 trillion.

Of course, at the level of the entire Eurozone, there IS an alternative. As several commentators have argued over the last few days, the European Central Bank could fire up the presses. It could flood the world with Euros just as the Fed is flooding the world with dollars. It could do so until Euro inflation - currently around 2% - takes off.

But if you're a normal everyday punter in Germany, why would you feel any better about that? You almost certainly never wanted the Euro in the first place, and went along with it only because you were assured it would be the rock solid Deutschemark by another name. How are you going to react when your Euro savings are obliterated simply to shore up the PIIGS?

At the end of the day, a bout of Euro inflation looks increasingly likely - all the other options are simply too hard for Europe's rulers to swallow. German taxpayers are going to be left feeling just like these American furry animals feel about the Fed's antics on the dollar printing press (HTP JWK):

PS If by any slight chance anyone is reading this thinking the inflation storm won't affect us, today's re-acceleration of UK inflation to 3.2% - above market expectations - is an excellent reminder of reality.

SUNDAY, NOVEMBER 14, 2010

Spending Your Money

The short version

We assume everyone watched Martin Durkin's spirited assault on Big Government last week (clip above and you can watch again here).

But discussing it with various people since, Tyler has been struck by how few actually realised that government is now spending more of our money than it allows us to spend ourselves*.

Say it again - government is now spending more of our money than it allows us to spend ourselves.

According to the latest OECD stats, this year the UK government will spend an astonishing 53% of our national income. That's the figure quoted by Durkin in his film, and also the figure we show on BOM's sidebar (it relates to so-called General Government, comprising both central government and local authorities).

So - just to hammer home the point with an outsized mallet - for every pound we earn as a country, the government spends 53 pence of it, leaving us with just 47 pence.

And our government is spending more of our income than the government of virtually any other major economy, and way more than the OECD average:

Greece and Ireland, those notorious fiscal basket cases?

Yup, you guessed it - their governments are actually spending less than ours (48.8% in the case of Greece, and 46.9% in Ireland).

Now for some unfathomable reason, HMG does not admit to such a high percentage in its own figures. In fact, George's June budget reckoned the percentage of GDP spent by government this year will "only" be 47.3% (2010-11).

But as we've blogged before (eg here), there are some serious doubts about the official HMT figures. In particular, some of their spending figures are included net of receipts (eg spending on public sector pensions). We'd rather trust the OECD numbers which conform to an internationally agreed and monitored standard.

More fundamentally, the HMT figures calculate the government's share as a percentage of GDP at market prices, rather than the much more meaningful - and lower - GDP at factor cost.

Que?

In plain English, GDP at market prices is measured including the taxes government levies on goods and services, including VAT. Thus, the more government taxes our spending - by for example increasing VAT to 20% - the higher is GDP at market prices. Which means that government spending as a percentage of GDP is correspondingly reduced.

Or in other words, by increasing spending taxes, HMG can manipulate down its own share of GDP.

GDP at factor cost excludes such sales taxes and gives a much truer measure of our real national income, and the share taken up by government.

BOM's old friend Prof David Smith has spent his entire distinguished career monitoring Big Government (or Leviathan as he prefers to call it - see clip above). And he has calculated his own measure of government's share in GDP, measured at the more meaningful factor cost. Here's one of his charts showing what happened over the last century:

Take a moment to study that chart (click on image to enlarge).

A hundred years ago, before WW1, government spent 10 - 15% of our national income, and private citizens got to spend all the rest - ie the money they'd earned. But in the following 70 years, successive governments grabbed more and more, so that by the early 80s they were spending over half our national income.

There then ensued nearly two decades of real struggle under Thatcher, Major, and Prudence, to rein back. Even so, government's take never fell below 41.8% (touched briefly in 1999).

Over the last disastrous decade, of course, it's been one-way traffic. Nay More Boom 'n' Bust Brown let rip, we hit the inevitable bust, and once again we find ourselves with government spending more than half what we earn.

Now let's all remember that simple fact. And let's all try to make sure we tell others around us.

And next time some self-serving Big Gov type pops up on telly saying we could solve the fiscal problem by increasing taxes, feel free to shout at him/her.

The problem is not too little tax.

The problem is too much government spending.

*Footnote - It should be noted that the OECD's 53% figure covers all categories of government spending, including transfer payments (mainly welfare benefits and increasingly debt interest payments). That of course is normal fiscal accounting practice, as also applied by HMT. It shows the proportion of our national income spent by the government. Now, clearly we aren't saying it all goes on direct consumption by the government, because around one-third of it goes on those transfer payments, which the government routes into somebody else's pocket. But the key point is that the government is taking 53% of national income away from those who have actually generated it. For sure, the government then hands a chunk of it out to citizens it considers deserving, but that shouldn't detract from the essential point. The burden on those famous wealth creators (via current and future taxation) is 53%.