...a blog by Richard Flowers

Friday, June 26, 2015

Day 5289: Fluffy footnote: what IS this DEFICIT thingie, again?


I cannot emphasise the following enough: The Deficit is NOT the National Debt. The deficit ADDS TO our National Debt.

I'm sure that Tim Lord Tim (@timfarron) and Mr Norman Conquest (@normanlamb) get this. But too many politicians clearly DON'T.

So: Economics for Elephants 101…

The Government raises about seven hundred billion quid in taxes.

But they spend nearer to EIGHT hundred billion pounds on health, pensions, benefits, schools, guided missiles and Boris' hairdo and the rest.

The difference, the amount extra needed for that spending, about a hundred billion pounds last year, is what is called the DEFICIT and we need to BORROW that from somewhere.

(Mostly, actually, it's borrowed from pension funds more that international banks, but the boys in the City still get a nice cut).

I'll say it again because I really cannot emphasise it enough: The Deficit is NOT the National Debt. The deficit ADDS TO our National Debt.

As of March 2015, the total National DEBT amounted to ONE THOUSAND, SIX HUNDRED BILLION pounds (£1,598.5 billion) or 86.6% of GDP*. That's SIXTEEN times (or SIXTEEN years of) the annual deficit.

And it's going UP.

The INTEREST that the country pays on the debt we owe already is forty-three billion pounds (£43 billion) or around 3% of GDP. Or about the same as we spend on the Department for Education or the Ministry of Defence.

Even if Master Gideon were to eliminate the deficit tomorrow – and the cuts to do THAT would be STAGGERING – we would STILL owe sixteen-hundred billion pounds, so we would STILL have to pay that forty-three billion pounds EVERY YEAR just to stand still.

(Like an interest-only mortgage, or just paying the minimum on your credit card – the debt NEVER GOES AWAY!)

And I'll say this YET again: running a deficit ADDS TO our total national debt.

Running a SURPLUS, on the other fluffy foot, (raising more than we spend; the OPPOSITE of a deficit) means reducing the total debt.

And it’s ONLY a surplus if you reduce debt

(*Or, in an extreme case, where you have NO national debt running a surplus would mean paying in to a sovereign wealth fund.)

– if you spend it on absolutely anything else then you are SPENDING, and NOT running a surplus.

Spending is still spending, even if it’s spending on things we’d rather wish away.

When people say "it’s BAAAAD to cut spending!" my Daddy often replies: "I want to cut the amount of spending that goes to international bankers. You want to give them more and more".

A surplus gives us a CHOICE. We can choose to run a LARGER surplus to build reserves – or rather, as our financial advisors usually advise us, to pay off debts first – OR we can to run a SMALLER surplus and spend a bit more (or even cut taxes a bit).

Though at some point – probably about 2018 – Master Gideon will say "…and now that we're running a surplus I can give you tax cuts…"

At which point, obviously, it STOPS being a surplus again.

IF we reduced the TOTAL debt, we could reduce those £43billion interest payments. And cutting down the amount that we have to pay in interest lets us spend more in future on other things, like schools, hospitals, soldiers, and hairdos.

Why do we not just run a surplus?

Well, as the man said when asked for directions to Tipperary, I wouldn't start from here.

There are a frustrating number of left-wing commenters who will say the likes of: "the Coalition borrowed umpty-billion more in 3 years than Labour borrowed in 13." Clearly without the slightest recognition that what they are saying is that they wanted the Coalition to not run a deficit, i.e the cuts to be a hundred billion pounds a year more savage. Often, and with no sense of irony, while saying that austerity is unnecessary.

The Government is committed to a great deal of spending – salaries for doctors, nurses, soldiers, teachers; building projects; aircraft carriers; £43 billion in interest… They cannot very simply just hit the "stop" button on paying those and many other things, any more than you could, say, cancel your rent or heating bill.

In 2008, tax incomes contracted very sharply. It was ALWAYS going to take TIME for spending to be brought down in line with the new fiscal (meaning how much money the government gets) reality.

i.e. in 2010, a deficit was INEVITABLE.

On top of that there is a question of POLICY. Overspending by the government when the economy is going down the tubes is supposed to HELP. At least that's what Liberal Economist JOHN MAYNARD KEYNES says, anyway.

The strength of the economy is (forgive the waving of fluffy feet) connected to the amount of money and goods moving about in it.

(You CAN get into an argument about there being too much money chasing too few goods driving up inflation, but go too far in that direction and you'll wander into controlling the economy by cutting the money supply through the hiking of interest rates and that way lies the failed madness of monetarism.)

Government raising taxes is taking money OUT of the economy.

(So is putting it in your piggy banks by the way, but that's not a lever the government controls.)

Government spending puts money back IN to the economy.

So running a DEFICIT is a BOOST to the economy because the Government ADDS more money (strictly, adds more than it takes away, or what we call adds "NET").

(And the FLIP side is that running a SURPLUS… or in fact ANY actions to cut a deficit – raising more from taxes or putting less back in spending – tends to SLOW DOWN the economy. As we saw in 2011, following the Coalition's first economic rescue remedies, raising VAT and cutting capital spends.)

So why not just run a deficit forever?

Some people actually suggest that we should! And they often point out that most governments for most of the time DO run deficits (and get away with it).

Let's just suppose we had a balanced budget. Don't laugh. If we knew the economy was growing, and we guessed that we would have, let's say, £20 billion more next year…

(As I said yesterday, the Bank of England expect growth to increase the economy this year and next, which will – everything else being equal – increase the Treasury's tax IN by about £20 billion.)

…then we could have two choices for next year's budget.

Number One: increase spending (or cut taxes) by £20 billion, keeping everything in balance. That would be the CLASSICAL economic approach.

Or, Number Two: we could say: "well, how much could we BORROW so that the INTEREST PAYMENT on that would be £20 billion…" and if interest rates are 2% then that's a TRILLION (a THOUSAND billion) pounds. Which would pay for a LOT of hairdos. So why not have that trillion pounds NOW.

(Though, you may observe, this is kind what we have actually already done!)

In theory, then, if the economy is growing, you COULD continue keep increasing the total borrowing, and with it increase the interest we have to pay, so long as the increase in interest keeps pace with the growth of tax revenues.

And indeed this is probably the thinking behind those people who say that thing about most governments running deficits most of the time.

But it doesn't work.

(If it did you'd have invented a perpetual motion machine, and that's impossible!)

It doesn't work because you are GAMBLING. Gambling in the biggest way. You are gambling that the economy will grow FOREVER. Not just that, that it will grow in every year forever, that it will NEVER, EVER NOT Grow.

Because in ANY year that the economy shrinks, then you cannot afford as much future payments of interest so you have to PAY BACK some of the TOTAL DEBT… and – as the man said in the note – all the money is gone, you've spent it. Go directly to the IMF, do not pass go.

And after 2008, do you REALLY REALLY REALLY believe in betting that the economy will grow forever? Can you with a straight face say you can "abolish boom and bust?"

(If you do, I have a perpetual motion machine I would like to sell you!)

Trickle-down economics, by MC Escher

So we shouldn't borrow at all?

Borrowing money that you spend on building your economy, that is borrowing for INVESTMENT, can WORK.

But a LOT of the time, it's borrowing just to SPEND, which is actually a PONZI SCHEME – a very famous kind of FRAUD.

It pays the REWARDS now (more spending) out of the money drawn in as investments (more borrowing) rather than as a return on those investments actually generating anything.

"Investment" is a word that has become very DEBASED since the time of New Labour, because they would SPIN things and used "investment" (because it sounded good) when they actually just meant "spending" (which sounded all "tax and spend" bad!).

It's the difference between borrowing money to buy a FARM, which then grows things so you can feed yourself and sell the extra which makes new economic growth, plus you've still got a farm; and borrowing money to buy FOOD, which you then eat and you're left with only the debts.

Things are slightly different for COUNTRIES than they are for PEOPLE. If people run out of money for food, they go to the food bank. If countries run out of money they go to the WORLD Bank…

What happens to countries in real life is that the more they borrow, the more EXPENSIVE it gets to borrow MORE.

Interest rates are (partly) to do with how much RISK a loan has.

(A "secured" bank loan like a mortgage has lower risk, because the bank can take your home back if you stop paying. That's why unsecured WONGA loans have much higher risk and so much higher interest rates than bank mortgages which are secured on your home. That and Wonga being EVIL.)

If you borrow a LOT, then the lenders start to think you are less likely to be able to pay them back. So the RISK is greater. So they charge you MORE in interest.

Eventually, you get to the GREECE-style position where more lending is SO risky that there's no way you can afford the interest payments let alone repay the original loans.

How are we supposed to bring balance to the force, then?

In the age of MR GLADSTONE, what we now call CLASSICAL economics taught that Governments shouldn't mess up the economy by interfering, so they should try to run a BALANCED budget (i.e. only take as much tax as they were going to spend; and only spend as much as they raised in tax).

But what Professor Keynes thought (remember him!), in the light of the GREAT DEPRESSION (aka Mr Frown) was that the economy would still go through cycles of BOOM and BUST.

So what the Government OUGHT to do was to try to act like a COUNTERWEIGHT: overspend during the recession years to add stimulus to the economy and speed up recovery; AND run a surplus during the boom years to try to reduce the overheating and make the next crash smaller when it came.

(Clue: Mr Frown OVERSPENT by OVERBORROWING during the BOOM years and we had the BIGGEST BUST IN HISTORY. This is NOT coincidental, whatever Hard Labour apologists may say!)

The REAL truth though, is just how POWERLESS people feel in the face of these enormous and sort of nebulous "economic forces". "Globalism" and "Austerity" have a huge impact on people's lives, often directly when it comes to Disability Living Allowance or Bedroom Tax, or pay freezes and redundancies, or immigration and off-shoring. But nobody really "gets" where all the money went, and so it feels as arbitrary and capricious as those old (ironically) Greek gods randomly smiting us mortals.

The old economy – the one where Labour and Conservatives are alike in only seeing one "good", which is to shackle yourself to one job – is entering a death spiral.

What we need to look at next, is how a Liberal economy would start to empower people against the "new economic gods", to share our resources better, freeing people both from poverty trap AND wage-slavery, and giving them back the power to change their local, national and ultimately global economies.

Fluffy footnote to the fluffy footnote: and GDP? What's that?

*"GDP" or "Gross Domestic Product" is a way of measuring the size of the economy; it is the total value of everything produced in the country, and is sort of like the country's "salary". It is a useful benchmark to compare against.

In 2014, the United Kingdom had a Gross Domestic Product of roughly one thousand, eight hundred billion pounds (that is about £1.846 trillion).

(This, incidentally, makes us the FIFTH largest economy on EARTH, overtaking France.)

The Government took about 37.5% of GDP in taxes, about seven hundred billion quid (£690 billion).

But the Government SPENT about 43.2% of GDP, or nearer to EIGHT hundred billion pounds (£795 billion).

The difference is the DEFICIT (about a hundred billion pounds in 2014).

Remember, in case I haven't mentioned it enough: The Deficit is NOT the National Debt. The deficit ADDS TO our National Debt!


Martin Howes said...

If the government needs more money, why don't they ask the Monetary Policy Committee to create some more money? In normal times creating money causes inflation but when inflation is 0% then I'm not sure what the problem would be.

Millennium Dome said...


"Why not just create money?" is a good question. Thanks for asking.

As it happens, it's one I've answered before. At some length!

But, as you point out, we are in the rather special circumstances where liquid money is being massively sucked out of the economy by the banks consolidating their balance sheets post-2008 coupled to ongoing Euro crisis and the general massive deflationary shock to the system.

But you can't do it forever.

And I wrote about THAT too: