A Budget to Forget

"If we subtract spending on welfare and debt interest then we estimate that the rest of public spending would be cut in real terms by an average of 1.4% a year compared to an average increase of 0.7% in the Thatcher era."
Institute of Fiscal Studies

It was a budget we all expected just before a General Election, a budget aimed at claiming maximum votes. It was quite simply a farce. No real change anywhere, savings cancelled by further spending promises, it felt like a budget for an era gone by where the economy was once perceived to be humming along. Mentions of cuts were detailed after the actual event, with yet more 'efficiency savings'. Call me sceptical but surely if it was that easy to cut billions in Government spending, then why aren't they doing this already? Never in history have I seen a Government be able to bring down a budget deficit like ours with 'efficiency savings', only real cuts can carry out the required correction. Of course the truth eventually came out. The press picked up on the fact that Chief secretary to the Treasury Liam Byrne confirmed that the Labour Government would have to make larger cuts than Thatcher did back in the 80's. However I still don't believe Labour would do this. It stinks of Jim Callaghan who took over the mess Harold Wilson left him, talked tough, but never had the conviction to administer the cure.

What's amusing in all this is people's shock to it all, 'Tougher cuts than Thatcher, well I didn't think it was that bad', well think again, you won't get common sense from the media. Thatcher never had a deficit like this. She came in when interest rates had peaked. She came in when Unions were Striking everywhere, North Sea Oil production was on its way up and private debt was no where near what is today. Thatcher had it easy! We have everything in reverse at this current point in time. Still it will work itself out, won't it?

Growth is what we need or what we are told. We need to ensure a return to growth and this will solve everything, right? Communist Russia grew for years during Stalin's reign of terror, but it wasn't the paradise that the propaganda portrayed. Governments can grow an economy like now by borrowing from future generations but the bill has to be paid at some point. Communist economic systems recorded growth but this growth included people never having goods they wanted. Governments made Steel, Cement, machines that no one used but at the same time people in these countries couldn't get basics such as bread or clothes, items we now take for granted. They couldn't get homes. Russia has historically been one of the largest Oil producers in the world but its people couldn't even buy the stuff as it was rationed during Communism. The state needed the oil to to pay for imports as natural resources were the only exports the central planned system could sell to the West. They had growth but people weren't satisfied, peoples lives didn't get better. Governments can grow economies but they can't meet peoples individual needs, innovate and create like a free market can.

When you hear a politician saying we need 'to lock in growth' its just political engineering, telling people we need growth rather than letting people, as individuals, determine what they want to do, what they want to consume and produce. It's time to let our economy shrink if need be and put it on a more sustainable long term path.

IMF Greek Bailout

Well not quite a bailout, but it stinks of another 'Greenspan put'. If the market won't lend to you, we will. The market now knows there will always be a lender of last resort, again another moral hazard. I'm sure the Greeks will now be able to sell their bonds, in fact rates may even come down again as the market can rely on the IMF to buy if Greece gets in real trouble. A further inflationary wave among the existing ocean of expansive monetary policy. Problem is, the plaster doesn't cure the Cancer patient. They can get lazy once more. Why train as hard as the other sprinter to compete when they keep making the race shorter for you.

The Eurozone should have let the Greek Government fail. People may look at this stance as uncompromising but this is how free markets work. No one objects to small companies failing, indeed it frees up societies resources, labour, land and capital for others to use in a more productive manor that satisfies peoples needs. When it comes to Governments, people rationalise that they should print, get bailed out etc, but if Greece was allowed to fail this would be beneficial to the Euro and also for the Greek people.

It would have sent a signal that the EU is serious in maintaining discipline on Governments. Either Greece's Government would have been forced to shrink by market forces and the Greek people would have got more competitive or what I feel would happen is the Greek people would have just left the Euro, thus leaving the nations that are serious about trying to have a sound economy under the Euro.

Greece should have left. I can't see their culture getting real. They blame international 'speculators', the Germans, the Euro anyone but never themselves. They are not man enough to admit to the error of their ways and if you can't do this then you can never learn from your mistakes and improve. Let them have their drachma, they would probably encounter a short term inflationary bounce as they regained monetary autonomy once more. So called economic commentators would use this as evidence to support their theory that the Euro is a straitjacket. The bounce wouldn't last and their economy would tailspin into a basket case state once more over the long term.

Franc Fort

Back in the 50's, 60's and 70's the French Franc was like the British Pound - a basket case. For years the French had used the currency to try and solve the problems of the day but on all occasions it never worked. When the ERM was introduced throughout Europe its aim was to achieve currency stability between nations after Bretton Woods collapsed. It meant all Governments had to peg their currency to the German D-Mark, the cornerstone of the scheme in effect 'borrowing' anti-inflation credibility from the Bundesbank. The problem was other countries would always keep revaluing as they couldn't keep pace with the Germans uber-hard monetary stance. Ironically it was France's Socialist leader Mitterand who decided to get France serious and a policy known as the 'Franc Fort' was implemented. He liberalised markets, allowed unemployment to go where it had to, cut government spending and so forth. They didn't use the currency and allowed people to get competitive once more and in turn won the respect of the Germans who in effect exported their harder monetary stance to France. I'm not saying France is a free market utopia (far, far from it) but they are in a better shape now thanks to such policies. I also don't agree with currency pegs, but the peg meant the French had a commitment to track the Germans on monetary policy. The Euro of course removes the peg factor completely.

"As the chancellor made crystal clear, there is going to be no devaluation, no realignment...The soft option, the devaluer's option, the inflationary option would be a betrayal of our future, and it is not the government's policy."
John Major, days before the pound exited the ERM

Well the Conservatives tried but failed. The UK couldn't stand the heat or rather we are still stuck in a bygone age where we believe the pound to be still the best currency in the world, hence not for the first time we valued the pound way above market rates, in this case we overvalued it against the Mark. What a bunch of pansies we are! Speculators made great gains from the event at the time, many are critical of the money men for profiteering at a nations expense.

However what about the speculators that bet against the Franc at the time? No one tells that side of the story, where those speculators lost a bundle. Ten years prior the French wouldn't have stood the heat, their culture would have been too weak, but the Mitterand 'Franc Fort' meant they could maintain the peg, admittedly with great difficulty. The market still didn't believe the French, thats why they bet on a similar devaluation that had happened in Italy and the UK, but they underestimated the shift in French culture that had occured during the past decade and the determination of the Government not to bow to short term outlooks.

'Sound as a pound' is still a popular saying but its lost all meaning these days, referring to a time when the pound used to be sound compared with the worlds other currencies. A more fitting title going forward may be to replace the 'sound' with 'unsound'.

Market Prices need to be allowed to do their Job

Market Prices are there for a reason. Profit, Loss, Bond Yields, Currency Exchange rates - prices all directing economic activity in an uncertain world where we all have infinite desires and wants but limits in our productivity to meet them. Don't use a currency to solve your problems, it will just embed the rot further. Let prices do their job.

The Children's Budget

"I shake my head in despair. As the Chancellor faces a terrible fiscal position no one outside the Treasury will believe the forecasts. When I saw the public spending plans I nearly fell off my chair"
Michael Saunders, chief UK economist at Citigroup

"The increase in debt servicing costs alone will be between £35bn and £47bn per year in 2008 money. That is more than the annual transport budget. It is about the same as the entire annual defence budget, and about half the annual education budget."
Danny Gabay, head of Fathom Consulting


In 1909 David Lloyd George, Chancellor of the Exchequer, delivered what became known as the Peoples Budget. It's primary aim was to raise taxes on the rich in an attempt to redistribute wealth within society, which in its day was a historical and radical set of measures. One Hundred years later, Alistair Darling delivered another historic budget, however it was under quite different circumstances. With finances spiralling out of control and a country heading for the worst post war recession, there was no room for social justice. Again a Labour government had spent too much. History will judge it as the Children's Budget.

The repetition of all the budgets figures are not required here, suffice to say the numbers are truly horrendous given the optimistic forecasts the government has used. Some of the areas of worry are:

Future Economic Growth
We are in the midst of the worst recession any living person would have experienced. Looking back at history when events like this happen, economies take years or a decade or more to recover from these credit excesses. The growth projections given yesterday were lies. Not even Mr Darling believed them. The idea that the economy will grow at the end of the year, and be in the thick of a new boom within a couple of years is nonsense. The economy will continue its decline for this year and the next. If there is any recovery after - which this author does not believe - it will be weak at best. Not 3.5% growth. The IMF have recently projected -4.1% and -0.6% growth for the next two years, however they are still playing catch up and their projections have always been wrong. Expect further revisions to these numbers.

Peaking of Debt levels
The government claims that debt will peak at around 80% and again it is more lies, and the markets know it too. It will go much higher. For readers of this blog you will also be aware that this is only the official debt figure. There's many off book debts to come, just at the time they claim debt will peak.

Deficits turning to surpluses?
In order to try and pay the debt back the government needs to be running budget surpluses. Estimates again, state that the deficit will drop below the £100B mark around 2013/2014 with the admission that it may take a decade to balance the books - to just break even. Then we get to the point where we need to be running surpluses to pay for all this debt. We can let our children worry about that. Whose going to fund all this? Isn't global capital low, with the high saving nations in Asia enacting their own stimulus plans? The main buyers of Government bonds have been foreign buyers but for how long?

All of the above is based on government estimates. Estimates that will prove to be as wrong as the estimates of 2008, or the ones in 2007 and so on. There were no proposals to try and balance these figures, which is to be expected as the election looms with unpopular decisions being put back. However the longer the government postpone action, the worse the hardship will be. By not creating a credible framework for balancing the books the risk of further gilt strikes are inevitable. David Cameron again had no polices that would attempt to rectify the perilous position as he follows the focus group discussions not wishing to disturb his poll leads, sending signals to investors that Britain has no intention of paying its creditors back.

The budget was full of contradictions. We had the various environment measures for wind power and then there were incentives to build more Coal power plants along with tax breaks for Oil and Gas. They announced they will pay people to buy new cars, which is in effect throwing money away. We may as well employ some people to dig holes and another set of people to fill them in, rather than subsidise car purchases - at least it will keep the unemployment figures down. If double glazing sales start dropping is the government going to pay people to smash windows in order to create artificial demand? There was extra money for the Job Centre network, when the job market is shrinking. A scheme to back mortgage backed securities, dead assets, further preventing liquidation that is needed in order to bring about the recovery Darling mentions. However the biggest move was an introduction of a new high income tax.

The 50% rate of tax was welcomed by many - "get the rich, they got us in this mess" as many will say. However readers of this blog will be aware it is government that got us in this mess. Unsound money, central planning price stability created huge distortions in the economy. However this tax increase is just a foot in the door. We will all be paying much more in tax in the coming years like I have previously mentioned - crushing any recovery for a generation or more. It was the increase in income tax by Herbert Hoover and then Franklin Roosevelt that assisted in the prolongation of the great depression. By hitting wealth we are also sending a signal to the rest of the world, that if you work hard in the UK we will confiscate your earnings. Suggestions of a brain drain has begun before any of the real hardship has even started. Before our boomers begin to retire. Before we run out of cheap energy. Before printing money has had its full ruiness effects and so on. It also marks a further nail in the coffin for the city of London as a financial center of the world.

With the above there is no hope of retaining quick growth again. By taxing the entrepreneurs who create jobs and wealth for us all we are further impoverishing ourselves. Then there's the point will they pay? There could be a negative effect with more people looking to avoid the tax. Tax revenues could actually fall, as less jobs are created as successful business leaders and entrepreneurs wonder what will happen next. The IFS has recently supported this claim, however I don't think they appreciate the full damage of a policy such as this.

Healy or Howe?

There were discussions about if the increase in income taxes represents a return to Old Labour, or if the cuts to come in spending represent a return to Thatcherite economics. We are a long way from Old Labour 83% high tax brackets, but we are heading in the same dangerous direction. Then there's the myth of the supposed Thatcher Monetarism economics that prevailed during the eighties. Government spending barely moved during her time as prime minister. Standing at around 42.5% in 1977/78, it was 41.7% ten years later. She actually spent more than Ted Heath and Harold Wilson as spending on government rose 32% in real terms through the eighties credit boom. Thatcher kept this fact quiet as she prided herself on the illusion of getting government out of the way, controlling the money supply, the Milton Friedman philosophy. In Milton Friedman's later life he would be critical of the governments and central banks who inflated in his name, rejecting his original ideas that they could be trusted to control the money supply. The Austrian Economists always told him governments could never be trusted. Nevertheless taxes and unprecedented public spending cuts will be required - both of which we have never experienced in tandem. We will need more substantial cuts then just "savings efficiencies" to balance the books and tax rises that can actually make an impact on the deficit.

The government are also starting to admit they may have to take losses on the bank bailouts they carried out, rather than the profit many believed. As I have said before I will be happy to get half the money back. Wait until the losses really start stacking up. There will be an incredible strain in the gilts market for years to come, with further money printing to cover the shortfall as investors appetite for our debt wanes. Indeed questions of Britain's AAA rating has become mainstream news now, as a ten year old could do the sums and realise they don't add up.

Green Shoots?
Before the budget there had been more discussions of green shoots of recovery or the bottom of this and that. These green shoots will be mentioned for years to come as I have mentioned before, many will be fooled by the bull moves in this bear market we find ourselves in. I started this blog around this time last year and everyone was saying the same. The 'worst is behind us', 'the credit crunch won't effect us', 'the UK has sound fundamentals' with everyone having an almost religious belief in the state of the economy. There is plenty more pain to come. Mistakes of history are being repeated which are once again impoverishing society. Unemployment has only just begun its climb. The next bubble, government debt has yet to pop and cause havoc. Energy prices and commodities are historically low. Retirement has yet to set in. As the year goes on the FTSE will hit new lows possibly hitting levels around the mid 1990's in a best case situation.

So the Children's Budget has been announced. A decade of deficits, and a generation of hardship. These were the debts I have been talking about. The debts I knew were in the system, waiting to hatch out and there's much more to come. The debts that are now staring my generation and future generations in the face. Many Western Governments will find themselves in a similar situation, but Britain has managed to come up with the largest deficits of the developed world, even without the substantial stimulus packages other nations are putting in place. The greatest asset we have is a long history of democracy and peoples individual rights, but we have a government that is continuing along the path towards bankruptcy. It's all unsustainable and must be stopped, immediately, if not for our sake then for future generations sake.

Dr. Doom

As the worlds leaders continue to make mistakes and economies continue their decline I found the following video of particular interest.



For people not aware of who Marc Faber is, he is known for his bearish views on Western economies and how the problems began with Black Monday of 1987 from which point the Central banks embarked on expansive monetary policies and would not let the free market function. You could dismiss the above video as economic thespian commentary. After all high inflation only happens in distant lands, with historically weak economies. Argentina and Zimbabwe used to be economic giants in their respective regions, with prosperous living standards for their people, yet economic crisis came and ruined their peoples way of life. Some of the points in the video are very interesting:

• "The Fed will never raise interest rates to real levels" - Meaning they will give up on their currency. In the event of inflation running at 10% they will have rates at 1%. They won't even bother trying to bring the money supply under control and will just give up on the currency to keep inflating to pay government and societies debts. Of course this isn't free. It ruins the economy, but still this is what Central banks think will solve the credit crunch. When something goes wrong print (tech bubble pops - interest rates to 1%), when something else goes wrong print (housing bubble pops - interest rates to 0% and QE implemented).
  
• "We are a while from high inflation" - Dr Faber is precisely correct on this point. Inflation doesn't happen immediately. It's a gradual process. All examples of serious inflation have taken time to work through, even while calls about deflation were being made. The final chapter of fiat money is always destruction. There are still many chapters to go, but we are getting through the book at an alarming rate.
  
• "Totalitarian State?" - More state control along with less individual decisions in the economy signals the beginning of government control as it crowds out the private sector. Further Government debts are being imposed on its citizens without their consent. We still have the ballot box, so are a long way from succumbing to totalitarianism although it is perfectly plausible in the long run.
  

The video sums up the irresponsible stance institutions and Governments have taken in recent years. The debt burden can not be paid. The only way to not default physically on the debt is default by the printing press - the governments most dangerous weapon. Not 'A Step into the unknown' or 'will it work?' or 'Just enough to move the credit markets' - just plain debasement. Destroying genuine capital and saving that is so desperately needed at this current time to assist with the recovery.

It really was a historic week. The Federal Reserve have announced they plan to buy Treasuries by printing money, not real savings, but with fictitious money. The history books of the future will illustrate this event as a milestone, a turning point where the great credit crunch of 2007 got a whole lot worse. Ben Bernanke has now openly admitted that they are printing money, no swapping of assets, parking of securities just printing new money, to buy government debt. This is always how it begins. As public speakers continue talking of moral hazards they miss the biggest moral hazard of all, that of fiat money. A money with unlimited supply means governments can inflate and bail out everything, with no immediate cost. Perpetuating the irresponsible behaviour from reckless individuals, squandering societies scarce resources.

Budget Deficits are rising, seemingly by the week. A latest forecast for Britain has come in at 12.5% for next year, with the IMF saying Britain has the worst fiscal position in the Western World. Unemployment relentlessly carries on rising, with forecasts of 3.3 million or even as high as 4 million people out of work, putting further downward pressure on economic activity and increasing public spending to cover those out of work. As the private sector reacts to the market forces correctly by reducing pay and redeploying labor, public jobs are sheltered in the governments own wonderland, thus further crippling the private sector, the real engine of human prosperity. As state spending increases it is not only consuming scarce capital that could be used by the productive private sector, but labor. Private sector talent heads into the public sector as conditions worsen, thus stifling innovation and future economic growth. Trade figures deepen as international markets further dry up, meaning more firms cutting jobs.

It will be interesting to witness the coming budget report form Alistair Darling. Will he have a credible fiscal framework (as though there is one now, as the BoE buys government bonds with printed money)? People are still not with the program. The public are still talking about property, stocks, a recovery, the bottom of this market, the bottom of that. The inevitable bull moves in these great bear markets will no doubt fool many into a false bottom. People still don't appreciate the severity of the issues we face.

The FSA has recently begun to look into setting limits against income multiples to be lent against houses. 3.5x salary is being proposed, with suggestions of a 15% minimum deposit. If the above is the case, I can't see many people buying homes. Most British people don't have the discipline to save, never mind save the huge sums required for a house. Why do we have regulators? Why do we have regulatory institutions such as the FSA and the ratings agencies? So after the crisis has hit, they can come up with the regulatory framework. It's similar to a civil engineer not putting supports into a bridge that gets used by the public, and when a disaster occurs admitting that they should have put supports in place as the bridge never stood a chance. Will the new framework work? Of course it won't. The market is smarter than any bureaucratic institution. Regulation doesn't get to the root problem, as true free markets regulate themselves.

Religion was seen for centuries as an institution of wisdom, a beacon of light, defending people against invisible evil forces. As time passed, the enlightenment, the progression of science, slowly religion became exposed for what it was, a mass cult following of stories passed down from generation to generation with no real rational basis. Rather than religion being the saviour, it was indeed part of the problem. Catholic and Protestant divisions in Ireland, Hindu and Muslim tensions in India, centuries of pogroms in central and eastern Europe against the Jews. It became a convenient means to segregate and persecute people. When Fascism rose, Catholicism praised it for its opposition towards Communist and Socialist parties. Movements that believed in equality. Just like religion, Central Banks are just an institution run by a select few, who are not the solution to 'market failure' but are part of the problem. Dr Doom may be viewed as a 'non-believer', just like atheism was demonised during religions dominance. Dr Faber knows the cause of the problems we see, and thus what problems these policies will create further down the road. Back in 2002 Ben Bernanke made a speech entitled "Deflation: Making Sure "It" Doesn't Happen Here", in which he now seems to be implementing the very policies he proposed 7 years ago.

"The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt ... Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. "
Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, 2002