This is the last part of this Blog Series and you can read the earlier bits at these Links:
The Counterpart to High State Spending - High Borrowing
Invariably whenever a Socialist Government embarks on a high level of State Spending, it has to fund that Spending and it is usually too difficult within the Political constraints of Western Economies to tax People and Businesses within the Economy at a level that would cover all the Spending (and to be fair that would make little sense anyway because a CONTROLLED amount of State Borrowing can be worth doing and affordable provided that the Economy is growing at a sufficient rate), and as a result the Government has to borrow money by issuing Bonds.
The French Government has followed this kind of policy of Deficit Spending for something like 30 years or so where the Economy is just about growing fast enough to mean that the Debt to GDP Ratio stays within acceptable bounds even though the Government has run a Deficit for all those years. It is pretty obvious that many Left Wing Economists (I find that a very strange concept - to me such people simply did not understand their Economics Lectures !!!) claim this to be some sort of success and evidence that Deficit Spending as a policy can work - however, the reality is that French growth over all that time has been sluggish at best and I would suggest that is down to Government Spending that is too high (we saw this in Part 3 of this Blog Series) and that the Over-Regulation and rigidities within the Economy have also resulted in this malaise. It is yet another example where a great Economic Theory falls flat on its face when confronted by reality.
Sadly in so many cases we have seen Left-leaning Governments let this Spending and Borrowing get out of control and this can easily occur if the level of Borrowing is already high and then the Economy slows and this leads to Tax Receipts being reduced - this means that more Borrowing is needed to plug the gap and we start to get the problems we have seen far too often. This is also exacerbated because tough Economic times result in higher Unemployment and consequent higher amounts of Benefits Payments which also serves to worsen a Government’s Finances even more.
In an ideal ‘Keynesian’ World we would see Governments borrowing to fund Spending in a weak Economy but then running a Surplus (where they are raising more in Tax Receipts than they are spending on Public Services etc.) when the Economy is buoyant. In reality this always seem to fall apart as Government’s fail to run a Surplus in the good times and this means that when the bad times hit they have no spare Money/Capacity to enable them to spend and perhaps borrow in a controlled manner and they end up borrowing more on an already high level of indebtedness. Governments like this claim to follow Keynesian principles but in practice only do half the job !!
You can read more about Keynesian Economic theories here:
We saw exactly this scenario play out in the run up to the 2008 Credit Crunch and then in the period afterwards when the Conservative / LibDem Coalition took over from the Labour Administration in the UK. Up to 2008 the Labour Government had good Economic times but had failed to reduce Debt (in fact it had run up Debt in the form of ‘Off-Balance Sheet’ stuff like Private Finance Initiatives PFI and unfunded Pension promises etc.) and then when the Coalition came in the level of Yearly Borrowing (the ‘Deficit’) was enormous even though the incoming Government initiated a Period of Austerity. As always the usual Left Wingers claim that the Coalition introduced ‘savage’ cuts to Public Spending but n reality, this is a myth - the level of State Spending increased every year of the Coalition Government. What actually happened was that the Yearly Rate of Spending was reduced but it barely qualifies as ‘Austerity‘. There would certainly be justification in claiming that the Coalition’s priorities for Spending were wrong but the idea that not enough Money was being spent overall is rather silly.
Even now, 10 years or so later, the UK State is borrowing a huge amount every Year and we are adding to our already enormous Debt Mountain (by coincidence, on the day that I am typing this, we had some well received Figures regarding the level of Government Spending in January 2019 but for the full year the Government is still expected to borrow £25m). This is fine and dandy when Interest Rates are low but if and when Rates rise and the Government has to borrow at much higher Cost, we will be in trouble. Already the Interest Cost on our Debt Mountain is huge - it accounts for something like more than we spend on Defence and Education combined - and remember that is at low Interest Rates. If we keep adding to that Debt Pile and we then get raising Rates, we will come to a point where Government Spending on Public Services will be crushed by the Level of Interest Payments just to service the Debt. It is a mess - and imagine what a financially illiterate and irresponsible Corbyn Government would do to the already precarious situation (especially with their insane and purely ideological plans for mass Nationalisation of Utilities etc. which would add hugely to the Debt Mountain.)
Just to clarify, the Deficit is the amount of Money that the Government borrows every year (in the unusual event that it actually saves Money, this is called a Surplus) and this yearly amount then gets added to the Total Debt Pile which is the National Debt. The Deficit is the excess of Government Spending over the Money it receives in Tax Receipts etc. per year.
One of the other classic errors of Far Left Governments is the idea that you can get the Economy growing faster and this will raise the level of Tax Receipts and mean that you can get higher Public Spending without adding to the Debt. Of course there is some merit in this theory but again it tends to fall down in practice. This is the model that Trump is using in the US - but his Administration understands it better than Left-Wing Governments do. The essence is that Trump is borrowing more Money which is then pumped into the US Economy in the form of Tax Cuts and more State Spending with the idea being that the Economy speeds up a lot and this means the whole thing is affordable. The difference with Far-Left Governments is that they fail to understand the need for Deregulation and you need this to go along with the other changes to really make it work.
In reality there are probably no examples where such an approach has actually worked and I suspect a lot of this is because a Country that has high levels of State Control and a relatively small Private Sector lacks the ability to ‘absorb’ all the Money sloshing around and to make the Money circulate fast enough within the Economy to generate the extra fast Growth in GDP that is desired. If you read stuff on the UK Economy and others on a regular basis, you might have noticed that Governments often allocate a chunk of Money for a particular Project but it then turns out that they do not spend all of the Money because all the in-built frictions in the Bureaucracies involved make it practically impossible to do so. For example, a Government might allocate £10bn to build an Airport or something but in practice just getting the thing through Planning Processes can take forever.
The Trump crew get this because they are Deregulating at the same time as the other boosts they are pushing into the Economy - so they have more chance of it working. If you just spend more State Money without Deregulation along side it then you will find that the Economy just seizes up and you will not get the expected and hoped for growth (it is like ’pushing on a piece of string’), which then just creates a mess where the People are expecting lots of Freebies but the Economy is not firing fast enough to provide the Tax Receipts to pay for it all and consequently the Debt gets out of control. Exactly this kind of thing happened in Greece where Governments pandered to the Population with ever increasing Freebies such as retiring at 50 and all sorts of unaffordable and irresponsible largesse. Sometimes it is the responsibility of a decent Government to just say ‘No’.
However, the US Debt mountain is looking pretty excessive so it is doubtful that Trump will be able to get the Economy motoring fast enough to really make this pay off. There could be some big problems down the track…..
It really annoys me when I hear this line from Corbyn and his Buddies that “Austerity is a Political choice” - it is the biggest load of nonsense ever - and that’s even if we ignore the fact that there has arguably been no Austerity. This is garbage because the need for a reduction in State Spending (I won’t use the word ‘Austerity’ because as we know there has not really been any worth the name) is not something that a Government can choose but it is imposed by the Markets. As an incoming Government (or an existing Government for that matter), you can only borrow what the Bond Market will let you borrow. It seems to be that Western Governments can in the main get up to maybe 120% or so of GDP in their Debt Mountain (from memory I think the UK Debt Pile is around 90% of GDP or something now) before which Bond Interest Rates are sort of OK but once they go over this level the Rate of Bond Interest spikes up and you get a Debt Crisis where it just gets too expensive for a Government to borrow more because the Cost of servicing that Debt just makes it unaffordable.
It is one of those problems where everything is alright…….until it isn’t.
If you think back to the Eurozone Debt Crisis around 2010 or so, some of the Southern European States went from Bond Interest Rates around 3% or so up to as much as perhaps 8% or more in a very short space of time (often within a few days). What is happening here is that Investors in the Bond Market demand a higher Rate of Interest to compensate for the higher Risk of Default (a ‘Default’ is where the Country fails to repay the Bond and the Investor loses all or some of their Money - if only part of the Bond Capital is lost, then this is called getting a ‘Haircut‘) and at a certain Level it is just too high and the Government has no choice but to stop spending Money it doesn’t have and doesn’t raise from Tax Receipts and this is when you really get ‘Austerity’ like has happened in Greece.
Of course, a big drawback of Socialism is that it doesn’t necessarily fit well with the concept of ‘Democracy’. The problem arises because it is easy for a prospective Government to promise the Electorate amazing ‘Free’ things and it becomes an arms race to see who can offer the Voters the most giveaways. This is all well and good but it means that over time we can get to the point where Government Spending on various ‘Gifts’ to the Population in the form of very well-funded Public Services and ever lower Taxes etc., such that the Government has to borrow more and more Money to fund this Spending and when times are good and the Economy is growing nicely, they can get away with this for a bit. However, once the difficult times hit again (and they always do - Gordon Brown famously said “The End of Tory Boom and Bust” and of course his tenure ended in the biggest Depression since the 1930s - he was right though, it wasn’t a ‘Tory’ Boom and Bust…….) it all very rapidly collapses and the Population then have to pay an extremely high price for the Government’s irresponsible behaviour. It is for exactly this reason that Left Wing Governments are always bad for the least wealthy in Society, despite their pretence of sticking up for ‘the Poor’ and the ‘Working Classes’.
I think it was probably Socrates or some other Greek Philosopher who came to the conclusion that Democracy was doomed by its own inherent flaws because you would always get this problem of prospective Governments bidding up the Freebies to get elected - and at some point it would always collapse (as Maggie Thatch used to say, “The problem with Socialism is that sooner or later you run out of other People’s Money……..”). This might have led to the idea that the ‘best type’ of Government was a ‘Benign Dictatorship’ but I am not up to speed on all that.
Another amazing wheeze that Socialist Governments employ to cover up their Economic incompetence once things start going messy is to start printing Money and paying Bills with this now highly devalued Currency. Of course the Lenders to the Country aren’t all that stupid and in response they drive down the Price of Bonds which again increases the Interest Rate on any borrowing the Government attempts to do (by this stage they probably can’t get anyone to lend to them though) and really any Money Printing is to pay Government Workers and People within the Country. Another negative impact occurs because the Bonds are often denominated in a Foreign Currency (such as the US Dollar), and a devalued Local Currency means that in effect the cost of paying Interest increases via the Forex translation effect. Before long this all leads to ridiculous Inflation Rates and the Poverty of the Masses goes off the scale - just look at Venezuela now to see this taking place before our eyes (and ignore all that silliness by Corbyn and his mates about US Sanctions - they were imposed after the problems started).
For more on how Printing Money usually leads to Hyperinflation and considerable Economic misery for the People of a Country, skip over to Wheelie’s Bookshop and get a copy of ‘When Money Dies’ by Adam Fergusson which tells the story of the Economic Collapse in Germany between the two World Wars which ultimately resulted in Hitler getting into power.
You can read more about the theories behind Austerity here:
An insightful Video relating to the Political poles of National Economic models
My mate @TheRealGMonkee on the Tweets brought this 15 minute Video to my attention recently and I found it superb for explaining the different viewpoints and beliefs which drive the thinking of people on both the Left and Right of the Political debate. I fully recommend you watch this because it is such a useful concept for understanding how People think on particular Issues:
I fancied scribbling something about Macroeconomics because it is not a subject that gets touched on much and in general the perceived wisdom is that we should ignore Macro stuff when dealing with our Portfolios. I guess this is true to a large extent although I think it is helpful to have a sense of what causes Booms and Recessions etc. and the possible impact of incoming Governments - especially when the choices are quite stark such as a possible UK Election where we could have a Centre Right Tory Party up against a Far Left Loony Labour Party - this would result in very different Economic Policies and could do considerable harm to our Portfolios if Corbyn gets anywhere near No. 10.
An understanding of how various different Government Policy approaches can impact on an Economy is useful and this is particularly the case when looking at relative performances of Economies such as comparing the performance of Europe to that of the US - with the former being much more towards the Socialist/Communist end of things and the US more towards the Free Market approach. It is probably no accident that the US has consistently been a much faster growing Economy for certainly the Post-WW2 Years and as we project forwards it seems likely that the US will pull further away as Europe is held back by Policies that lead to stagnation and this is not helped by aging populations, low Birth Rates and high Wealth Inequality and now a backlash against Immigration which is necessary to keep growth moving along (but Uncontrolled Immigration appears to have a negative effect and cause considerable Social problems which are not without an Economic cost).
In terms of a more immediate impact, things such as Tax Cuts, Interest Rate Cuts, Government Spending Booms, Consumer Spending splurges etc. can speed up an Economy (this is not permanent and can often be very fleeting) and things such as higher Taxes, reduced Government Spending, higher Savings levels and Over-Regulation can cause an Economy to slow. It is probably these more immediately impacting aspects of Economic Management which are more relevant to our Portfolios and it is my view that we must always be on the look out for Recessions as these are what can really hurt our Portfolios as we usually get widespread Market falls.
Of course, in terms of our Portfolios we must also consider our own Risk tolerance both in terms of our psychological ability to take a hit and also our Financial ability to withstand the damage. For me personally I am not working or anything and am in effect in a state of ‘Drawdown’ on my Portfolio so it is very important for me to take a very cautious approach. Someone who is in their 30s and in a solid profession can probably take on a lot more risk.
On the other side of this, when we are in a very positive Economic Environment and a bit of a ‘Goldilocks’ scenario (‘Not too hot and not too cold‘) then it makes sense for us to really put the hammer down on our Portfolios and to max out our Exposure and go for big gains in an assertive and confident manner. How nice it would be to experience times like that again, but I guess at some point they will return !!
On the subject of Over-Regulation it strikes me that Europe and some other Western Economies like Japan have introduced so much regulation and ‘friction’ within their Economies in recent decades that this has slowed growth considerably and in the case of Europe there has been a deliberate policy of high levels of immigration which have covered up the problem. It is very easy to get growth within an Economy by bringing more People into a Country but it is misguided to think that there are no costs in doing so - both in terms of Social dissatisfaction and inefficiencies caused by too much demand for limited resources (e.g. your Doctor’s Surgery is unable to expand quickly to meet increased demand so the level of service and effectiveness of treatment reduces).
Now that the existing Populations within most European Countries are staging a backlash against these lax policies, it could get very difficult for moribund and restrained Economies to show any kind of growth. This will be a significant test for these Economies and I suspect we will see a lot more strife with the Public kicking off before Governments of the Left are rejected from power and we see more Right leaning Governments which tend to be a lot more Free Market and pro-growth. For an example of where this has happened before, just look at how the UK changed on the transition from the Socialist ethos of the 1970s to the Thatcher Reforms of the 1980s. We also saw the same in the US when the Government changed from President Carter to a more dynamic pro-growth agenda under Ronnie Reagan. You might not like it, but it is probably coming.
Another huge failing of the Left is how the whole philosophy is based on the idea that Governments know best. This is quite frankly ridiculous - without doubt the Private Sector produces disaster after disaster after disaster but as I explained in earlier Blogs in this Series, if you get Governments doing everything in an Economy as per Communism, then you will really see what a disaster is (do I really need to utter the word ‘Venezuela‘ again?).
I was going to write more about what can create Economic Booms and Busts in terms of Government Policy choices within these Blogs but I have decided to push this back and do a separate Blog on it at some point in the future.
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