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17 June 2017

It’s the economy, stupid (2)

Tag(s): Politics & Economics
In the 1992 US Presidential election one of then Governor of Arkansas Bill Clinton’s aides hung a board in his campaign office with the words “It’s the economy, stupid”.  It was intended for internal consumption but came to be the main message of Clinton’s argument to the American voters as to why President George Bush should be removed from office. It has come to be a truism that in every election voters vote with their wallets.

 We have come to the end of a highly dispiriting general election. I do not want to comment on the outcome or indeed the politics. I do however want to comment on the complete failure of any of the political leaders to show that they have any understanding of how the economy works. I cannot say why people voted the way they did. It maybe that it had something to do with their wallets. But it had little to do with the nation’s wallet.

There is much talk about the deficit and austerity. But the national debt has never been so high. In 2010 when the Coalition Government came to power the UK national debt was about £790 billion. It now exceeds £1.5 trillion and grows at a rate of £5000 per second. Secondly if we factor in all unfunded liabilities including state and public sector pensions and public finance initiatives it is closer to £5 trillion, some £80,000 for every person in the UK. Only by a complete overhaul of public finances can this be dealt with. Interest payments on the government’s debts now exceed £1 billion per week, more than is spent on defence.

In the NHS Pension Scheme accounts there is a deficit of over £250bn, more than twice the NHS annual budget.  It’s all off balance sheet. Parliament has become a pressure release valve, a place where general grievances are aired but little detail dealt with. Every day we are hit with a tidal wave of complaints about the failures of the state, but instead of reaching the obvious conclusion, that the state should be smaller, the politicians all compete to show you how much more they will spend and so go deeper into debt.

More than once in the election campaign I heard politicians tell us that we’re the 5th richest country in the world and so we can afford all this largesse. But we’re not the 5th richest country in the world. I don’t know which is but we are economically bankrupt. Our total debt, mostly off balance sheet, is unaffordable. We may be the 5th largest economy in the world if we mean as measured by Gross Domestic Product. But as I have said before on these pages GDP is no measure of wealth. It is a measure of consumption or expenditure.

Despite its name GDP does not measure what we produce; it measures what we spend. Imagine measuring a business’s health in the same way. It isn’t generally understood that GDP goes up if our government spends more. It goes up if we borrow to spend. All of the GDP growth in recent years came from three sources: personal borrowing, government borrowing and immigration.

If the natural laws of economics had been allowed to work, prices would have gone up to mop up the extra money in circulation and thereby keep supply and demand in balance. Inflation is not a disease; it’s the natural correction for too much money chasing too few goods. This means GDP will go down but we’ll end up with a healthier economy.

The natural laws of economics haven’t worked because we import the shortfall in goods and borrow the money to pay for them. Our trade deficit is the best measure of our failing economy. It’s simple proof that we consume more than we produce. Rather than wanting to grow GDP through increased borrowing and more government waste, we should be working to reduce our trade deficit.

In the 1960s when I became aware of such issues the TV news would on a monthly basis report on the balance of payments. It was generally understood that this was the single most important measure of our economic health. Now they report on a daily basis the irrelevant movement of the FTSE100 and on a monthly basis the irrelevant movement of GDP.

We should move the UK government to using Generally Accepted Accounting Practice (GAAP).  As a director of a company by law I have to take into account future liabilities that the business will incur. As a pensioner I live off the savings that I made in the past. The state doesn’t have to do these things, so its finances aren’t clear. All the things that MPs vote for or against are on the basis of fudged numbers. They collectively preside over a giant Ponzi scheme.

One way that states have been able to grow so big and so invasive is by running up deficits - which their ability to debase money allows. In the past 40 years the government has run a surplus only six times, and that’s only by fudging the numbers. Under GAAP it would never have run a surplus in modern times.

Every fall in output since 1971 has been preceded and caused by growth in credit. Politicians are fixated with using interest rates to control people’s appetite for debt but that doesn’t control the money supply. Over the four boom/busts we’ve had since 1971 we’ve been spectacularly bad at preventing the buildup of excess credit.  The way to do it is to constrain the ability of banks to conjure up credit out of nothing. That requires some far reaching banking reform.  Until we do that we’re going to have disruptive credit boom/busts. The next one may come in the car market. Almost nobody buys a car now. Instead they “lease” it and trade it back at the end of a fixed period. The car companies all have gigantic financing arms with huge levels of debt. The “asset” on the other side of the balance sheet is a notoriously depreciating one that may not have the maturity value that they assume. Since the financial crisis £30.9bn of UK car loans has been sold to investors.

And this of course is in the private sector. My concerns are not just about how badly the politicians all run the economy. It is also how badly business leaders run parts of the economy. Roughly speaking half of corporate America is quoted and half is not. In the last ten years or so the unquoted section has invested twice as much as the quoted. That has been sufficient to depress investment ratios and to push up profit margins on both sides of the Atlantic.

There has been a major change in management incentives in recent decades. The priorities of management are simple. In the average four years that a CEO is in power, he wants the company to make as much profit as possible, in order that he does the same via bonuses, stock options and so on. He does that by not investing, buying back shares with borrowed money and so on. That isn’t good for the economy as a whole, but it gets profit margins high in the short run. It also explains why productivity is so poor on both sides of the Atlantic.

Many of these companies are sitting on cash. The cash flows in an economy must sum to zero. You can’t have a fiscal deficit unless you’ve got a cash flow in one of the other sectors of the economy. We have – in the corporate sector.
I hope the new minority government doesn’t do all the things it promised to do in its manifesto. Instead it could learn from what other governments have achieved with more radical ideas:

1.       Abolish capital gains tax: Singapore has no CGT. As a result, it has proved to be a magnet for foreign investment, attracting 13% of all FDI into the Asia-Pacific region in recent years.
2.       Abolish National Insurance: Instead consolidate it in income tax and then people would realise that the top rate of income tax is over 60%
3.       Cut spending faster: Rather than the current tinkering the Chancellor should follow Canada and have a big shake-up. Following a thorough review, between 1995 and 1997, Canada cut federal spending by 10%, slashing defence, business subsidies and unemployment insurance, and shrinking total spending from 53% of GDP in 1992 to just 39% by the mid-1990s. The result was a 15-year boom.
4.       Cut red tape: the Prime Minister should follow Georgia’s example and slash red tape. We should commit to improving Britain’s ranking in an independent measure such as the World Bank’s Ease of Doing Business Index. Britain currently does dismally by this measure, making it harder than it should to register property, enforce contracts and start a business.
5.       Liberalise employment law: the government should make it easier to hire and fire workers, and to take on temporary staff, and abolish the minimum wage. Germany’s reforms in 2005 did just this. By 2011 unemployment had fallen to its lowest level for two decades.

And pigs might fly

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