Budget Basketcases

I haven't posted much of late. The main reason for this is that there are a couple of big topics that I've meant to post about, but knowing it would take a while I have never bothered to start writing them. So I didn't post anything...

The big topic in front of us at present is Government spending. Namely all those deficits and 'stimulus plans'. Our ever thoughtful governments taking it upon themselves to spend ever larger sums of unearned cash to stop the recession getting worse. How considerate.

Or not in my view...

Let me explain. In days gone by, we used to have something called an economic cycle, the main cycle often being 14-16 years in length. This had periods of expansion (where we lowered debt) and periods of stagnation or contraction (where we borrowed more). But now, following the inspired policies of intellectual heavyweights like Dubya Bush and our own Gordon Brown we are now trapped in a situation of ever-increasing debt.

The graph below of US spending (from http://www.mwilliams.info/images/obama-budget-deficit.jpg) illustrates the point. Governments (led by UK/US) now are just borrowing obscene amounts for which there is no plan to repay, despite what the spin doctors / idiot journalists say. If anyone dares question this, they are dubbed a doom-monger who does not understand the need to get out of recession. But there is a cost associated with debt, even if you don't repay it. The UK govt is likely to borrow £200bn this year (and probably the same again in 2010). At 5% bond rates (the current level) this is £10 bn of interest just to service. If rates went up to 10%, it would rise to £20bn. That is equivalent to 5-6p on the basic rate of income tax. Big sums. Now try multiplying it by 5-10 years of culmulative borrowing....

Problem is this can't go on forever. At some point time will be called on this nonsense. The likelihood of the above 10 year forecast coming true is low in my view. In the last couple of weeks, the UK has been put on notice of a debt rating downgrade. This is the equivalent of the bond markets telling us to get our house in order quick. Inspired policies like printing money (sorry QE) won't get us out of this pickle. Indeed they will make it worse as debasing our currency discourages bondholding, further driving up bond rates. At some point, we'll have to act - possibly drastically as in places such as Iceland (headline interest rates fluctuating in 10-20% range) or Ireland (drastic public sector cutbacks and 10% pay cuts). If we don't then we'll be consulting the Bob Mugabe book of fiscal discipline for ideas!

Meanwhile our leaders put off much needed activity - similar to my blogging really...

Dominoes...

Whilst the UK continues to pour more good money after bad, I noticed an article from arch-doomster Ambrose Evans-Pritchard (AEP) over the weekend about how the financial crisis is evolving in Europe.

I'm always wary of AEP's articles being factually biased. He seems to have an axe to grind on a number of fronts, with his favourite target of criticism being the Euro. But leaving aside the pros and cons of the currency at present, the bit that interested me was social unrest. His article mentioned riots in a number of countries over the past week, citing the example of Latvia.

Upon doing a search on it, it turns out it is true, but has been kept very quiet in the mainstream press. In the last week there has been rioting in a number of locations in eastern Europe. Generally, these are coming on the back of the introduction of austerity measures in countries that have run out of cash.

To my simple mind, rioting indicates people being surprised by a rapid downturn in events. In this instance, it seems to be young people realising that they have fewer opportunities 'to get on' in life. If circumstances change slowly, people adapt. They might become angry, but they won't riot. When things happen quickly, such as following say an IMF bailout, then rioting happens. (in the UK think Thatcher in the early 80's)

The key to avoiding trouble seems to be to put your house in order gradually, rather than having to be forced to cut spending by the global markets. Easier said than done.

Isn't it better to spray the cash around now and hope things get better in the future??!! (sarcastic smiley)

With limited 'real' cash around, the risk in the next year or so is for there to be an increasing number of sovereign defaults (countries running out of cash). What we are seeing now are the small countries being the first in line to take a spanking on the currency markets. The 'terrorists' in Iceland were the first to hit the buffers late last year. Now places like Greece, Latvia, Bulgaria and so on are following suit in a disorderly line. Even Ireland is on credit watch and could hit the buffers soon.

Then there are the big countries with spending problems. These include the likes of Spain, Italy and, dare I upset Gordon, the UK. These countries ran deficits in the good times and are now finding their government spending deficit is going out of control rapidly. Spain risks being the first to hit the buffers as unemployment is exploding at an incredible rate. They have also been running down their reserves, including almost all their gold, over the last few years. Now the kitty is empty...

The daddy of deficits (in value-terms) is the US of A. Last week, another $825bn of tax cuts and more spending was announced by Obama on top of a forecast overspend of $1.2+tr for 2009. Talk about pouring petrol onto the fire to help extinguish it! The mind boggles...

So, as the UK government commits potentially £100bn's to another bank bailout package, the dominoes continue to fall around Europe. Are we solving problems or making them worse?