Saturday, December 12, 2009

Government Debt - £300bn and counting

I’ve been reading a fair bit lately about the structural debt versus actual debt of the UK government. For those that don’t know the structural debt is the debt that the government would have regardless of the recession, the day to day borrowings that it has accumulated as a result of spending more than it’s tax revenues. At the moment the Treasuary says that it stands at £127bn, however independent bodies think it might actually make up a lot more of our £300bn national debt.

When this recession started the Conservative party began to talk about how Gordon Brown had failed to put anything away for a rainy day during the last decade of economic growth, but it actually appears worse than that. Whilst the economy continued to grow and grow the UK government continued to borrow more and more, continually spending more than tax revenues and running a deficit. Personally I think that we were extremely lax in opposition not to point that out then, and that we’re not doing enough now.

Look at it from the point of view of the public, you cannot borrow money and take on debt to support your lifestyle, it is extremely bad practice and likely to cause trouble later down the line. However that is what the government has done, and indeed it is something that the public have done as well, the economic growth of the last decade was, it now seems, built on debt, borrowing on credit cards and equity release from inflated house prices. Why did people think that this was acceptable? I would like to suggest that if the government of the day does not show sound financial principles in the management of the UK’s finances then unconsciously the public thinks that they do not have to. If the government is borrowing money, then why shouldn’t I?

Many people have blamed the mountain of personal debt on the instant gratification culture that we have today, and this seems to have affected not just the public but government as well. The current government had to deliver more to public services, it said it would spend more on the NHS and achieve it’s aims and regardless of whether it could afford it or not it was going to do it.

The splurge on public services in the last decade is the equivalent of an individual who wants to watch better quality television so they decide they need to buy a new 42” television but can’t afford it now, so they put it on hire finance, then they decide that that television isn’t delivering what they want, so they need to spend more to get it right, so they buy a new top of the range surround sound system, again on finance. But that’s still not quite right, they need to spend more money so off they go to  DFS and buy a new sofa, on finance as well. The problem is that none of this fixes the problem, the problem wasn’t that more money needed to be spent on it, it was the quality of programming in the first place that was the issue, and this is the situation the government is in now. For the past decade the government has spent more and more on the public sector without identifying the initial issues first. In fact new data from the Office of National Statistics is said to show that there has been no improvement in public services such as the NHS despite the billions more spent on them.

Lets go back to our man and his television for a second. He could afford to pay his debts every month (mainly because they weren’t going to be due for an excessively long time, 50 years say), but then one day his boss calls him into his office. “I’m sorry” he says “but times are tough, we’re going to have to cut your salary” so suddenly his income is less and he can’t afford all his outgoings anymore, but he’s got good credit so he takes out a loan to make up the shortfall hoping that his salary will go back up soon.

After a year of being told that business is improving by his boss and that his salary will go up again soon, he starts to run out of money again, so he goes back to the banks to ask for a loan again. Unfortunately because his salary has dropped to even less in the last year his credit score has dropped, he’s no longer AAA and the banks can offer his money but only at a huge interest rate, or perhaps they just say no. Either way it either costs him a huge amount of money or he has to default. In the end he has two options, get a new job that pays more or cut his spending, slash his costs, downsize his house, cancel the gym membership, drive a more fuel efficient car, get a cheaper haircut every month.

That’s the situation the government has got this country into now. It hasn’t quite got to the stage whereby our national credit rating has dropped, however there have been warning signs and the cost of insuring UK debt has skyrocketed. Two years ago it cost $5,000 per year to insure   £10 million of UK government debt against non payment for three years, now it is $52,000 as opposed to $2,000 for  German government debt and $22,000 for  BP debt. So to put that in perspective the market thinks the UK government is more likely to default on it’s debt than not just Germany, but a British company that makes up its economy. That is the state that our country’s finances are now in.

The Labour Party’s approach as laid out in the Pre Budget Report is basically option 1 and a tiny bit of option 2  for the man and his television (He’s going to cut back on his expensive hair cuts and look for a new job), they effectively want to raise more and more tax revenue but not significantly cut back on spending.

Personally I don’t believe that this is a real option, the only real option is to find or force substantial savings in government expenditure, live within our national means and handle the root cause of issues.  Lets go back to our man with his television, could he have just improved the quality of the television he watched by writing a letter of complaint to the BBC, or watching a different channel? Perhaps something simpler and cheaper? By analogy could we have fixed the NHS by just doing things differently rather than spending more and more?

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