Archive for May, 2013

Debt or Deficit?

Debt or Deficit?

There is a lot of confusion in the public mind between these two terms and this ignorance is deliberately exploited by politicians on both sides in order to underplay the problem we face.

But it really is very simple.

Debt is the amount of money currently owed by the government to the bond markets. The bond market is simply the forum for private investors, insurance companies, banks etc. to lend money to the government at an interest rate set by supply and demand. It has long been regarded as the safest option for investment by people and institutions with a low risk appetite, the proverbial Widows and Orphens market. So much so that the interest rate so derived is known as the ‘risk free rate of return’.

The mechanics of this system are very straight-forward. Every few weeks a government will offer to the bond market, X million of debt denominated in its own currency over a fixed term of anything from three months to thirty years. The treasury will make the following proposition: I am offering a bond which will pay back £100, (let’s say) one year from now and I want £98 for it today. So the lender pays £98 today and in exactly one year he gets back £100, so he gets £2 interest on a £98 loan which is an implied interest rate of (2/98)x100 or 2.04%. If the government has done its sums right, there will be more money offered by the market than is required from this particular bond issue and the bond sale is described as ‘oversubscribed’ and each bidder gets a percentage of the amount of bonds they bid for at the price offered.

The reverse is also possible. If the government offers a rate that the bond market thinks is insufficient the bid will be undersubscribed and there will be only a partial sale of the bonds on offer. This is hugely embarrassing for the treasury so they work very hard to get their sums right to avoid this.

Previously issued bonds are constantly traded on the bond market so that for any given maturity date, there is a clearing price set by supply and demand in the market. The treasury sets its prices to align with the spot price in the open market so that an undersubscribed issue is extremely rare. Bonds are constantly being rolled over so as one bond issue expires and the principle needs to be returned to investors, a similar amount is being raised through a new bond issue to pay it back.

If the government is not overspending, that is, if its income from tax receipts is in line with what it is spending then the total debt can remain static with the annual interest to the bond market becomes just one more line item of expenditure. If the GDP rises and the debt is static then Debt/GDP ratio actually reduces. However if the amount of debt increases faster than GDP then this Debt/GDP also rises. This is where most governments are currently.

Deficits arise when the amount of money being spent by the government exceeds the amount coming in by way of taxes. The difference has to come from the bond market and the amount of this excess adds each year to the total pool of debt.

The Deficit is the amount by which the Debt increases each year.

And this is where the sleight of hand is played. Politicians deliberately use the term deficit where the audience are led to believe that it is the debt that is being discussed. See the video above for recent examples. So a politician can say, truthfully, that the deficits are being reduced, but by mixing up the two words he can lead the audience to believe that is the debt that is being reduced.

It is not.

The debt is just increasing by slightly less than last year, but it is still increasing. So the statement is technically true but by flustering his words, with plausible deniability, he can leave the audience with a false impression.

This deceit is deliberate.

But you already know that politicians are professional dissemblers, right?

After the money’s gone


You may ask yourself, what is that beautiful house?
You may ask yourself, where does that highway go to?
You may ask yourself, am I right, am I wrong?
You may say to yourself, my God, what have I done?
 -David Byrne-

When trying to explain the mess we are currently in, the left will decry the greedy ‘Banksters’ and declare a failure of capitalism and the right will point to the Community Reinvestment Act and blame it on government interference.

Both are half right.

To see how we got to where we are it is necessary to start back in 1945 and bring together a number of different threads. After the end of WWII, the industrial base of Europe and Japan lay in smoking ruins and the USA reigned supreme as a military and industrial power. Its industry had ramped up to wartime production while being unaffected by aerial bombing due to the lack of range of bomber aircraft of the time. All of the Industrial countries (by which I mean North America, Western Europe and Japan) took on huge debts to finance the war. Europe began a massive reconstruction program to rebuild its industrial capacity, financed by the Marshall Plan to the tune of $12.7 billion ($152B in todays money) and a similar plan for Asia of $5.9 billion ($70B ITM). The US did this through a mixture of altruism and self interest in that it provided a bulwark to an expansionist Soviet Union, a growing market for its own exports, successful democratic allies rather than permanently subdued and resentful vassal states and in many cases, the money was provided in the form of loans which were repaid. Hard and soft power allowed the US to reshape international trade in a form more to its liking with freer trade with lower tariffs.

Wartime Debt

We can see from the graph above that this was hugely successful with most of the wartime opponents undergoing a ‘post war miracle’ that allowed them, by the mid 1970’s to bring their wartime debts to below 50% of GDP.

The 1970’s saw a number of post war effects come to a head. The baby boomers reached their 20’s and began demanding political influence and a more socialist economic system, through a combination of youthful enthusiasm and Soviet manipulation. This was the time of the communist radicals, the Vietnam War protesters, the 68ers of Paris and the various left wing terrorist groups financed by the Soviets and Libya. While the terrorists mostly failed in their objectives, the political centre ground lurched to the left and more and more social programs and entitlements were demanded and enacted. At first, this was financed through ever higher taxes until it was found that there was a limit to how much you can tax an economy before it began to have a negative effect on growth.

The back slope of the Laffer Curve had been reached.

So tax rates were lowered by Regan in the US and Thatcher in the UK and following their success, by many others worldwide. The public, however, still demanded ever increasing entitlement spending, so the difference had to be found somewhere. This is when national debt rates began to rise again throughout the western world as governments looked to the bond markets to fund the entitlement spending that the public demanded but were unwilling to pay for through taxes. The media, the voters, the political class and academia cheered them on.

While Thatcher’s legacy as a fiscal conservative is secure, having brought Debt to GDP down from 45% to 25% during her tenure while greatly improving economic growth, Regan’s is more mixed. He did reduce taxes and increase economic growth, but he also embarked on an arms race with the Soviet Union rather than use the savings to reduce debt. It can be argued that eliminating the threat of nuclear Armageddon was worth the price, but the fact remains that that debt increased from 30% to 50% during his time. The upward trend continued under Bush Sr who had a gulf war to pay for. Clinton during his two terms reversed the deficit and reduced the debt, but Bush Jr and Obama significantly increased it again.

All of them however, failed to tackle the ticking time bomb of demographic changes that would mean that as the baby boomers reached retirement age, there would be significantly fewer younger workers to pay for their retirement. The baby boomers embraced feminism which brought vast numbers of working age women out of the kitchen and into the workforce. This had a number of long term economic effects. Firstly, working women with newly available birth control, decided to have fewer children in order to better balance home and work life. Two income families bid up the price of property to way beyond what could be afforded by a single salary, forcing more women into the workforce in an ever increasing property price arms race. Rapidly increasing home prices gave an illusion of increased wealth and people began to view the family home as an ATM machine to borrow against for current consumption.

During the last 20 years, an apparent increase in wealth has convinced more and more school leavers to go to university. In the US and to a lesser extent the UK, this has seen them enter the workforce already massively in debt. Young couples, already in debt are putting off having their first child till their mother’s early thirties when fertility rapidly declines and the time available to have subsequent children is greatly reduced. As a huge phalanx of baby boomers rapidly comes to retirement age, this process is now about to create the perfect storm.

The children of the Baby Boomers begat the echo boom of those born in the 70s and 80s, who have had to delay forming families due to their educational indebtedness, their wives’ reluctance to begin childbirth without financial security and the lack of available housing at reasonable cost due to their parent’s generation reluctance to sell up and downsize at a price less than they think their properties are worth due to a fallback after a lifetime of booming prices. This now middle aged generation have produced far fewer offspring than their parents.

It is normal, in the western world, for someone with three or four siblings to have one or two children themselves. Thus a falling population is a mathematical certainty. The retirement system was set up sixty years ago when every couple could expect to have four children and sixteen grandchildren, each earning wages and paying taxes back to the previous generation with a comfortable surplus. This model fell apart in the 90’s and the number of workers per retiree is rapidly dropping to an unsustainable level, i.e. the falling number of new workers can no longer sustain the increasing numbers of retirees.

This demographic problem has been obvious for decades and has been criminally ignored by the political class that preferred to spend now and forget about paying later because it would be someone else’s problem. And the public have only themselves to blame for ignoring the problem and failing to hold their politicians to account while believing the pretty lies. Instead of creating a “You get out what you paid in” system as was put in place in Chile when they took on board this problem decades ago, and as was half attempted in the US with the 401(k) scheme, the political class, with the acquiescence of the people, chose to ignore the problem and will soon have to face it straight on, without a backup.

This will not end well.

Letting the days go by, let the water hold me down
Letting the days go by, water flowing underground
Into the blue again, after the money’s gone

David Byrne

Shame on you!


“Shame on you!

They spit the words into your face. Every hard case that arises must, of course, be solved immediately by state intervention with a new bureaucracy with sufficient staffing and a generous budget. Anything else would be ‘unfair’. And if you don’t agree, you should be ashamed of yourself. Never mind what it costs, we’ll make the rich pay for it. Anyone who has ever delved into the comments section of the Guardian or the New York Times will recognise the narrative. The effectiveness of this approach is that it completely bypasses logic and goes straight to emotion for its impact.

And you know what? We should be ashamed.

We have created in the last fifty years a multi-generation underclass that has never worked and will never acquire the habits of work. We used to have a proud working class where self sufficiency was prized, where dependency was considered pitiful by your peers, where personal advancement and education and community were valued, where the first member of the family to enter university was a source of enormous pride for the entire family….

Until the dead hand of the state got involved.

In the 1970’s, the new generation of baby boomers, in their hubris, voted for and many of them administered a vast new program of welfare in order to improve the conditions of the working class. In attempting to remove want, they decided that they, as only intellectuals could, were best placed to run the little people’s lives for them. Instead they removed all responsibility and turned adults into children. What they actually achieved was the decimation of the working class and the huge expansion of the underclass. Now we have the second and third generation of useless parasites that survive by a combination of welfare and petty crime. They destroy everything around them, make the lives of their working neighbours miserable through their defiant and unchecked antisocial behaviour, ruin the schools and fill the prisons. The self regulating communities that kept this misbehaviour in check has been displaced by a careerist, self interested and self perpetuating bureaucracy on full pay with generous benefits.

You want thanks for the trillions that have been spent on them over the decades? London riots last year and flash mobs in Walmarts. There’s your thanks.

Their anger has been encouraged by legions of grievance-mongers who absolve them of all personal responsibility and deflect the blame to ‘Society’. They have a white hot visceral hatred for you, (the poor working stiff who has to pay for this through ever increasing taxes) because deep down they recognise the dependant squalor they have been reduced to and they blame you for it.

And as those 70’s radicals reach retirement age after a long and securely paid career with good pension benefits paid for by the (actually) working class, do they look back on their life’s work and reflect on the destruction their conceit has wrought? The hell they do.

Where is the shame?

The number of people on disability in the US has grown from 3m in 1990 to 9m now; in the UK it has grown from 0.4m to over 2m in the same period. Has there been an epidemic of work accidents these last 23 years that we all missed? No, of course not, with the move away from heavy industry to the service economy, most workers’ biggest physical risk is a nasty paper cut. It’s abundantly clear that politicians on both sides have cynically facilitated the transfer of the unemployed from dole to disability for their own ends. Those on the right did it to hide the embarrassingly large unemployment figures, while those on the left were more than happy to create a constituency of dependants who will forever vote in their interests to keep the welfare money coming.

Look also at the breakdown of type of disability. The percentage with either back pain or mental illness went from 18% (of a then much smaller number) in 1961 to 53% in 2011. It is no coincidence that vague back pain or depression are the easiest ailments to fake.  So Mary does the rounds between doctors until she finds some doddery old fool who will sign off on her sub-Oscar performance of depression or her pantomime of back pain, and now she is set up for life to doze in front of the TV while the cheques roll in.

Where is the shame?

Since the Lehman’s debacle in 2007 the banking system worldwide has been on life support. True capitalism has two sides, those companies that provide genuine value to their customers should flourish and those that fail to do so should disappear. On this point, Occupy Wall Street are absolutely right, those banks that have singularly failed in their duties should go bankrupt. But no, the zombie banks that deserved to fail because of their mismanagement are kept alive by their bought and paid for politicians at the taxpayer’s expense. This is not the free market, it’s not true capitalism, it’s crony capitalism. We reward incompetence and put the taxpayer in hock to pay for the failures of the politically connected.

Where is the shame?

We are constantly inveigled by the mainstream media and the political class that the answer to all our economic problems is ever increasing amounts of stimulus spending in order to boost the economy. Classic Kenseynism, though we of course failed to build up the necessary reserves during the good times.

But where is the money to come from? We didn’t create a rainy day fund during the boom times. We tried austerity, by reducing government spending, but the push-back from the public sector unions was too strong. We tried raising taxes, but the private sector started squealing and the tax take actually reduced with higher rates as the free economy was squeezed and we found the downslope of the Laffer Curve. We tried going back to the bond market, but they took a jaundiced view of our willingness or ability to ever pay it back, so they balked.

Which left us in limbo and so we took the coward’s way out with Quantitative Easing (QE). Let us be very clear what QE is, it is the Central Banks around the western world creating new money out of thin air and using it to purchase treasury bonds from their own bond markets. The basic economic law of supply and demand means that increased (artificial) demand increases the price of these bonds, which in turn, reduces their interest yield. This has the added benefit for governments that the reduced bond yield (i.e. interest rate), means that they can roll over their expiring bonds at reduced interest rates.

But, you say, surely we can’t keep adding printed money to the system without unleashing hyperinflation? And here we get to the crux of it, no we can’t, the coming hyperinflation will decimate the savings of the prudent, reduce the debt load of the indebted, so those who caused the problem will be, again, bailed out by government action and those who were prudent and had nothing to do with the problem will again be shafted.

Where is the shame?

We have become immune to the shaming language of the statists. Their remedies have failed and failed again.

They’re the ones who should be ashamed.