Wednesday, March 17, 2010

The UK as Catalyst for Crisis

The UK Budget

Inevitably, there has been a lot of comment in the UK press regarding the recent budget in the UK. As many commentators have identified, the problem with this budget is that it is so close to an election that it might be meaningless. Everything to do with the UK hinges on the forthcoming election. Perhaps more importantly, the UK may, if the election goes to Labour, may be the big test of the sustainability of massive government deficits, with a UK fiscal crisis potentially creating a broader crisis. It may also be the case if Labour does not win, but there may be a delay in the onset of crisis in these circumstances.

It is interesting that there is now increasing talk of the possibility of a hung parliament, or even outright Labour victory. In a recent post, I commented on the Economist's view that there is a coming battle between those reliant on the state for their livelihoods, and those who generate the wealth that ultimately funds the state. The UK is now in a position in which over 50% of the activity in the economy is rooted in the state. This is a situation in which there are more people reliant on the government keeping the spending taps open at full tilt, and a situation in which self-interest might short-sightedly determine the voting intentions of many of the electorate.

In this context, it is interesting to note the Telegraph column of Ian Cowie, who says the following:
What’s a first-time buyer’s vote worth? If you were longing to get out of rented digs, then a £2,500 tax cut – the most notable feature of the pre-Election Budget – might well be enough to do the trick. Nor is this group electorally insignificant. Official figures show that the number of people in privately rented homes has increased by 1m since 2001 to 3m today.
His argument is very simple - the budget is offering a bribe to one million of the electorate to vote Labour. Another Telegraph commentator quotes Professor Philip Booth of Cass Business School, as follows:
Almost every Budget measure [on Wednesday] involved a spending favour for some small group or other, or some tax relief for a group that the Government hopes to sway behind the Labour Party at the election.
The rest of the budget is simply a denial of the reality of the terrible state of the UK's fiscal position. Perhaps the most humorous addition to the budget was the addition of a so-called 'Green Investment Bank', with a remit to invest in a wide range of projects including 'green' energy investments. Among the targets are wind and solar power, both of which are virtually useless forms of energy generation. Within this provision, it is possible to see another expenditure aimed at a particular group, those who have strong beliefs in global warming, and is aimed at ensuring their votes go to Labour. By contrast, those who are cynical about global warming are not likely to vote against Labour on the basis of this expenditure.

Perhaps the most worrying aspect of the budget is the belief that the UK is about to enter a period of rapid growth. As Jeremy Warner of the Telegraph points out, a large portion of that growth is built upon an assumption of significant growth in exports, with the justification being that similar growth took place after the last £GB devaluation. As Jeremy Warner correctly points out, last time the £GB devalued, the world was not mired in an economic crisis.

Overall, what is apparent in the budget is an attempt to appease the clients of the state, and target narrow sections of the electorate through appealing to their self-interest. This is done with accompanying flimsy justifications, which serve only to allow people to tick the Labour box with no feeling of cognitive dissonance.

As you would expect, the other political parties have attacked the budget, but they still lack the will to really lead the UK and persuade the country of the absolute necessity for root and branch reform of the economic structure of the UK. What they are not telling the electorate is that, whilst Labour can promise to keep the spending taps open, eventually they will not be able to deliver on their promises. In other words, they need to tell the clients of the state that they are, whatever the promises of labour, going to eventually suffer cuts regardless of who wins the election.

The yield on gilts have climbed since the budget, and the head of the UK Debt Management Office (DMO) is yet again having to reassure the markets that gilts will not suffer a failed auction. That the DMO is having to makes such statements is of itself the story, not the statement of confidence. The UK is in deep, deep trouble, and a funding crisis must eventually come, unless serious action is taken to deal with the massive deficits. I have said it before, and will say it again, the current situation is one in which there is an agonising pause in the markets, with the coming election the only thing that is supporting the ongoing purchase of gilts. The gilt market is supported by 'wait and see', and this is a fragile foundation.

The real story, however, is the wider implications of a UK fiscal crisis. As I have often emphasised, there has been a stubborn resistance to the idea that the 'developed world' might be much, much poorer than many imagine. I have compared this belief to a dam, and each new concern about the economies of the developed world as small cracks in the dam. A UK fiscal crisis would represent the kind of crack that finally weakens the dam to the point of catastrophe. The likely outcome of such a crisis is that investors will flee to the illusory safety of the $US, before finally realising that the $US is in the line of the deluge.

Scenarios for the Way that the Crisis Might Resolve Itself

I recently added a comment to my last post, asking if the readers of my blog might be interested in my making a highly speculative post on how the economic crisis might finally resolve itself. Several readers expressed enthusiasm for the idea, and one suggested that I look at a best, middle and worse case scenario. The idea of a best to worst case scenario seemed to be very sensible, right up to the point where I started to write them up. The problem that arose was that, however much I tried to take an optimistic/positive perspective, the same problems started to emerge.

In particular, the underlying problems in the structure of the world economy simply would not go away, and no policy can reverse the underlying problems without considerable pain. The problem that I am referring to is the illusory level of wealth in the developed economies, and the fact that the world economy is still (largely) adapted to servicing wealth that is not really there. I have previously described the underlying causes of the economic crisis, which is to highlight that the entry of labour into the world economy has seen a massive supply shock, in which the labour force with access to the world market has approximately doubled, whilst the available resource for labour to utilise has not seen a commensurate rise (if you have not read it, I suggest reading this version of the argument as an introduction - note, there is a typing error; zero sum 'gain' should read 'game' ).

Interestingly, Alan Greenspan is now subscribing to the thesis that the massive input of labour was the root cause of the economic crisis, but is doing so to justify his argument that monetary policy did not cause the crisis. Whilst happy that somebody from the mainstream has finally noted what I identified long ago, Greenspan can hardly deny that the Federal Reserve also took a problematic situation, and contributed their own major input into the depth and scale of the crisis that followed.

Returning to the argument, the upshot of the change in the structure of the world economy is that we are now seeing a period of hyper-competition, in which wealth is moving from the developed world to the so-called emerging economies (I note that the Economist now calls them something like 'middle income'). However much money is created, however much money is borrowed, there is nothing that will change this process, short of bringing globalisation to a grinding and rapid halt. The essential problem that I was confronted with, when trying to paint optimistic scenarios, was that this change simply could not be wished away.

At its most basic, we can see the problems in the growth of the service sector in much of the developed world, all of which was designed to service debt fuelled economies, and the growth in manufacturing in emerging Asia to supply the debt fuelled economies with goods. Few now doubt that this structure was, in the end, unsustainable. However, there is a stubborn refusal to acknowledge the consequences of this system, and that it shaped the world economy in a way that now must change. Thus we have the policies of massive fiscal deficits, massive monetary easing and so forth. All of these policies are a stubborn denial of what we all know; that an economy can not live on overseas derived credit forever.

Greece is, of course, an illustrative case of what happens when there is a real possibility of having to live on the added value actually generated from within your economy. When the credit taps turn off, austerity follows. The economy in question sees their real level of wealth generation revealed and, as is illustrated by Greece, it is not a pretty sight. Even whilst Greece is trying (possibly unsuccessfully) to confront the underlying limits of their wealth creation, their ability to generate added value for exchange, much of the developed world is still in denial. Even as the signals, market analysis, and other indicators are increasingly flashing warnings, policy makers are clinging to the illusion that the developed world can return to the pre-crisis era.

The problem is that they are seeking to return to an era in which Asian countries steadily emerged as major competitors, but where the consequences of the emergence were hidden by Asian savings being recycled into developed world credit. In order for a return to this past, it is necessary for the credit to continue at pre-crisis levels. If, and it is a big if, they were to do so, the developed world credit junkies will eventually hit a level of debt that simply can no longer be supported. It is the Greek problem.

The problem for all of the scenarios that I played with was the same. At some point, the factories in Asia supplying goods into the developed world will need to restructure such that they no longer are reliant on servicing the credit fuelled portion of the developed world economy. In the credit fuelled countries, all of the jobs and services that are derived from overseas credit must also disappear. As indirect evidence of the problem of structure, I read the following in the Economist, regarding occupations showing growth in the UK:

England’s fastest-growing jobs between the second quarter of 2001 and the same period in 2009 include conservation officers (up 124%), town planners (94%), psychologists (67%), and hairdressers and the like (63%). Further investigation shows a big increase in semi-professional jobs (paramedics, legal associates, teachers’ assistants) rather than professional ones.
The report also identifies that employment in heavy manufacturing is in decline. I mention this story because it represents the last gasp of the credit fuelled economy that must eventually restructure.

The big picture is this; in a post, sometime ago, I made an estimate of the size of the US economy if overseas credit were withdrawn, and came to the conclusion that the economy would shrink by 17%. Again, this is comparable with the situation facing Greece. If we think of the growth in the occupations in the UK, a similar story might unfold in many countries. Many of the jobs that are supported and growing on the back of government borrowing and spending are simply unsustainable.

In trying to consider scenarios, they must all confront these problems, and I simply do not see a positive outcome. The other problem is that, in trying to create scenarios, I kept on bumping up against the ongoing denial of the situation by policymakers. It seems that, whatever happens, they seem to be willing to resort to ever more extreme policy. In the UK, for example, the Bank of England has printed money to buy over a year of UK debt issuance, and there is still the possibility of more money printing to come. The trouble with policy extremes is that the extreme policy of country 'x' does not operate in a bubble, but eventually impacts on the policy of country 'y'.

The more extreme the policy of country 'x', the more likely that country 'y' will see an extreme policy response. An example of this is interest rates and the carry trade. If country 'x' has loose monetary policy in conjunction with low interest rates, this encourages the 'carry trade', in which money from country 'x' goes to country 'y' to benefit from higher interest rates. Money floods out of country 'x', enters into country 'y', potentially causing overheating of the economy, and currency appreciation. The policymakers of country 'y' then have to come up with a policy response to counteract the results of the policy of country 'x', and it will be an extreme response, as the impact of country 'x's policy is extreme. That extreme policy response will not only effect country 'x', but many other countries, who will, in turn, have to respond.

In such a system, although each policy takes a while for the effects to become apparent, there will be a steady ratcheting up of extremes of policy. At this stage, we are starting to see the effects of initial responses to the economic crisis, and the lagging responses in policy as the effects become apparent. The problem is now that there is less and less in the hands of the policymakers with which to respond - the only ammunition left is printing more money. All over the world, there is a massive demand for credit to fund government debt, but how might such a wall of debt be funded? The borrowing of country 'a' impacts upon the borrowing of country 'b'.

In other words, the massive issuance of debt in country 'a' is acting in competition with country 'b', and investors face a beauty contest with many of the entrants looking like the ugly sisters of fairytale fame. The UK is just slightly more ugly than the other contestants. The risk is that investors will look at the contestants, and decide that they are all too ugly to be worth their vote. Within this competition, the uber-judge is China, and China has now added the Euro to its concerns about the safety of the $US. Yesterday's Cinderella is today's ugly sister. And sitting in the middle of the ugly sisters is the UK.

The foolishness, the denial of reality and the extreme policy that the denial has generated, has brought the world to the brink of an economic disaster. For the moment, the Greek crisis is on pause, but a more serious crisis is developing in the UK. If the UK should topple, as is looking increasingly likely as the UK election unfolds, it is very likely that it will commence the final stage of the economic crisis. However much I tried, I found no best case, and no middle case scenarios for the way the final stage might play out.

The pitiful truth is that I am hoping for two things; that the Conservative party wins the coming UK election, and that they have not been telling the truth about their intentions. I just have to hope that they win and take an axe to the deficits, and that they commence a root and branch reform of the UK's economic structure. Even with a collapse of the UK economy the most probable catalyst of wider economic chaos, it nevertheless remains a forlorn hope. There are plenty of other potential catalysts out there.

In summary, there is currently no sign of a best or middle case scenario. Instead, the flashpoints for a savage deepening of the crisis are multiplying. The UK is moving closer to the brink, and we now have to wait and see whether those reliant on the state, those bribed by the state, might stand back and make a hard choice. Is the UK electorate mature enough to demand the necessary hardship? I worry that they are not....

Thursday, March 11, 2010

The Use of the Expression 'Sterling Crisis' Increases Day by Day

It seems to be that jury is still out on the prospects for the UK economy; there are still a few analysts that believe that the UK might suddenly motor ahead. However, increasingly the commentators, analysts, and even some politicians, are coming to the view that the UK is in deep, deep trouble. For regular readers of this blog, this will come as no surprise, as they will know that the brewing crisis in the UK was apparent many years ago, and that the government's action has only served to increase the scope of any coming crisis.

One particular commentary in the Telegraph sums up many of the concerns for the UK economy, as follows:
Is it remotely possible that Mr Brown has succeeded not just in delaying the pain, but suspending it entirely? Here's why not. The key questions are these. Given the amount of policy action that has already been thrown at the problem, how come there is still so little sign of recovery? And by extension, will continuing to provide life support eventually produce the sustained recovery the Prime Minister promises, or will it only bankrupt the country before we get there?
When I first started this blog, I suggested that the UK was already bankrupt, and that it was just a question of time before this was accepted. I proposed that it would be necessary for either the UK to print money or default on debt and, lo and behold, the money printing solution appeared from nowhere with the Bank of England inventing justifications for the policy. When quantitative easing (QE- the euphemism for printing money) was finally introduced, I argued that it was nothing more than a method to pay for government profligacy, but nevertheless the vast majority of commentators and analysts bought into the Bank of England's justifications. It seems that they are increasingly rumbling the game:

Ian Stannard, currency strategist at BNP Paribas, said markets are fretting over how the UK will cover its deficit following the pause in quantitative easing by the Bank of England. The Bank has absorbed £200bn of debt, more than total Treasury issuance over the last year.

"The UK may have difficulty in attracting extra investors to fill the gap. We think they will have to do more QE as recovery falters," he said.

It has taken a long while, but it is starting to look like the game is up for QE. The Bank of England has described the current ending of QE as a 'pause', but that they may restart if they deem that the economic situation warrants it. The problem that the Bank of England faces is this; they originally justified QE through spreading fear of Consumer Price Index (CPI) deflation, even though no such deflation had yet occurred. They also, as I pointed out at the time, sought to mix in the use of the RPI measures, even though this was beyond their remit. As things stand, the UK inflation rate is high at the moment, and climbing:

It might be noted that RPI went into deflation, but RPI includes housing costs, which are determined by the Bank of England interest rates. At the time QE started, I predicted inflation being imported through currency devaluation. The same situation applies now, with the £GB continuing to sink:
LONDON, March 10 (Reuters) - The Bank of England's trade-weighted sterling index fell to a fresh 11-month low on Wednesday in the wake of data showing an unexpected fall in British manufacturing output in January.
The much hoped for improvement of the balance of trade has also not taken place. In fact, the opposite has taken place. The increase in imports, alongside a devaluing currency, does not bode well for inflation.

The current account situation is also seeing no improvement. As I have suggested before, the importation of inflation through currency devaluation takes time to fully impact, as many contracts and goods in transit take time to adjust to the new situation. As such, we can expect ongoing inflationary pressures lagging the devaluations.

In this circumstance, with inflation climbing, and realistic prospects of even more inflation, how might the Bank of England explain any further QE? When the Bank of England last started QE, they justified the policy with projections of CPI deflation, but the deflation never took place. It might be argued that this was because of QE, but even before the policy might have had an effect, there was no deflation (also, the idea that deflation is an inherently bad thing is something I have contested in previous posts). I doubt the Bank of England will get away with QE so easily this time around, as too many analysts are becoming cynical.

What we are now seeing in the UK is the brewing of a perfect storm. The underlying size of the UK economy, the size of the economy without borrowing, is very much smaller than many imagine. It simply can not support the level of borrowing that has been undertaken by the government. This was true even before the borrowing binge following the onset of the economic crisis, but the difference is now that the borrowing is concentrated in the government rather than consumers. The real size of the economy in relation to borrowing is the underlying problem, but other factors are adding to this fundamental problem.

One of these, which is commonly reported as a reason for weakness in the £GB and gilts (UK government bonds), is the political instability, and the prospect of an ineffective government after the coming election. This from the Wall Street Journal:
NEW YORK (Dow Jones)--The U.K. pound tumbled against the dollar and the euro Monday as investors worried that the upcoming national election could result in political gridlock, hampering the country's ability to deal with its growing debt levels.
Such sentiments are not rare, but there are other concerns, and in particular the relative health of the UK economy in relation to other economies. As governments issue record levels of debt, the competition for who is funded is intensifying. Again, it is an argument that I made long ago, and it is now an argument that is gaining a broader airing. Whilst other economies may look very bad, the credit will flow to the countries that look least bad and the UK is not well placed in such a competition. The result is that yields on gilts are climbing, meaning that funding the government is already becoming more expensive:
Yields on 10-year gilts have already crept up to 4.14pc, compared to 3.94pc for Italian bonds, 3.48pc for French bonds, and 3.19pc for German Bunds, though part of this reflects worries about higher inflation in Britain.
I undertook a search for 'sterling crisis', and the results speak for themselves. Some examples of the articles including the term can be found here and here. It is the increasing frequency of the discussion that is of real concern. As the £GB falls, as the doubts about fiscal policy gather more weight, as the prospects of a return to QE are discussed, the attractiveness of funding UK government debt diminishes. As concerns grow, the £GB weakens further, and as the £GB weakens the doubts are reinforced. However, underneath it all, the core problem is doubt about the solvency of the UK.

Just as in Greece, it appears that the electorate in the UK are taking their creditors for granted, and have not accepted (yet) that it is possible for the credit taps to switched off. The Labour Party and the Conservative Party are running scared of the polls, and are afraid to propose the cuts necessary to restore the UK's fiscal situation. The Conservatives talk of concern for the credit rating of the UK, but are not offering the policy proposals that might reassure creditors. Meanwhile, the Labour government is suggesting that the coming pre-election budget will be 'business as usual', even whilst a currency and funding crisis is brewing. At some point, the UK electorate needs to wake up and accept reality, but the prospects for this are dim.

In a recent article in the Economist (last week's print edition), they discussed the coming battle between the interests of the older generation and the younger, and the private and public sector. Of note is that, with an increasingly large share of the UK economy in the hands of government, the government us building a client state - where any serious cuts to government expenditure threatens the livelihoods of ever more individuals. The more the government spends, the more people are dependent on government expenditure, and the harder it becomes to develop the political will to cut expenditure. My guess (and it is no more than a guess) is that underlying the uncertain outcome of the coming election is the imbalance between a growing client state, and those in the private sector.

The Economist, which seems to be returning to better analysis, suggests that, in the end, it will finally be necessary for countries like the UK to have reform imposed upon them from outside. In other words, the politicians will need a crisis for them to tackle the structural problems within their economy. It is rather a depressing indictment of the politicians that are supposed to lead us, that they need such a crisis to do what should in any case be done. Within all of this is the concern that the UK is supposed to be a 'mature' democracy, in which the electorate should know better. It seems though, that they lack the maturity to face up to the severity of the economic situation.

The truth is this; if the UK continues on the current course, there will be wider and deeper damage when resolution is imposed from outside, and the wider and deeper the damage the more people who will lose their livelihoods, including the current clients of the government. In other words, nobody will win from carrying on with the current situation. Those who live as clients of the government need to recognise that their interests are inextricably bound up with the private sector. It is in not in the interest of anybody to risk a funding and sterling crisis. In the end, everybody will bear a share of the pain. Somehow, I doubt that this will be learnt before the coming election, but we can but hope....perhaps then the politicians will have the courage to do what must be done?

Note 1: Thanks for the many comments on the last post.

Lemming asks how we might determine sustainable economic growth. I am not sure that there is an easy answer to this in the current system. In particular, the manipulations of the money supply by central banks, in conjunction with fiscal tinkering, serve to bury what the real state of economies might be. A particular problem is that the policy of government 'x' can have unexpected impacts on country 'y', such as the way that QE and zero interest rates encouraged asset price inflation in countries like the US. How is it possible to untangle such effects? I long ago provided (what I believe to be) a solution to these problems, but doubt the solution would ever be adopted.

A commentator called 'D' noted that there is a situation in which government is in bed with select businesses, and suggests that this means not all blame should be placed with the government. I would argue that this is still a problem of government, as government should not put itself in this position. The more honey in the government pot, the greater the number of bees buzzing around the pot. The solution is less honey in the pot, and some fierce constitutional constraints. Sorry, a short answer, but all I have time for.

An anonymous poster corrected me that, in the event of default, somebody still pays; in this case the creditor. You are quite right, but I hope that this was implicit in the rest of the post.

'Rural Idiocy' added an interesting quote as follows:
"The Bank for International Settlements says Britain needs a primary surplus of 5.8pc of GDP for a decade to stabilise debt at pre-crisis levels, given the ageing crunch as well. The figure is 6.4pc for Japan, 4.3pc for the US and France."
Certainly food for thought.

As ever, Lord Keynes also posted several comments which challenge the views of this blog. It is always good to see the alternative views presented. As for the other comments, I have read them with interest, but do not have time to respond to them all. However, they reflect the high standards of commentary on this blog, and I feel privileged to have such a thoughtful readership.

Note 2: As with many posts, there is much else that I could say, and many subjects that might demand more attention. For example, I could talk more about the other indicators for the UK economy, but will leave that for this time. If time allows, I may try a full review of the UK in the future.

Saturday, March 6, 2010

The Great Lie

My apologies for the long time since I last posted. I have several three-quarter finished posts sitting waiting to be finished but, in each case, I struggled to find anything new to say, and want to avoid just commenting on 'events'.

I finally came around to writing this, due to a comment from one of the blog readers, who goes under the name of 'Death to Bubble Addicts' and who quoted another blogger (not named, sorry). It was actually a comment that was particularly interesting because it was such a succinct presentation of an argument that is at the heart of the blog. I will quote the relevant sections:
It’s astounding that people can’t grasp the simple concept that wealth (as opposed to money) does not grow on trees. We, individuals and governments, have consumed more than we produced, for a long time, or in simple terms we spent more than we earned. Now we, individuals and governments, must earn more than we spend, for a long time. Yes, that will cause a depression. It can’t be avoided because the consumption has already occurred and payment is due.


Our previous debt-bubble-fueled-overconsumption will be paid for, either by those who consumed, those who provided the goods, those who provided the credit, or the taxpayers. No matter which group pays, that group will consume less because they are paying for prior consumption. It doesn’t avoid anything if the government stimulates using more borrowed or printed money, just shifts the burden from one group to another. Creating future tax burdens by running large govt deficits just shifts the blame down the road a bit. Creating inflation is a tax on savers, which subsequently reduces their ability to consume. Defaulting on debt will be ruinous to creditors.
I read these two sections, and thought about the ongoing message of this blog, and found myself appalled at the amount of complexity - amongst commentators, economists, policy makers - that is used to hide these simple truths. I will repeat the points, just to make sure we can show how simple they are:

  • We have spent more than we have earned, and one day will have to pay back the borrowed money we spent.
  • Someone has to pay for the borrowing (unless we default), and those people will, at some point in the future, not have money to spend.
Much of the purpose of this blog has been about trying to take to pieces the complexity that is used to hide these simple and self-evident truths. In fact, everything we see in the actions of policy makers and the discussions of most economists, is actually an attempt to hide these basic realities. We can see the complexity in the way that they bury simple ideas under jargon (e.g. quantitative easing = printing money), or dense formulae. There is only one formula that is really important, and that is the one that calculates income vs. expenditure.

One way that the borrowing has been justified by policymakers and commentators has been the use of the word 'investment' and this word was widely used in the UK in particular. It is worth pausing and thinking about the word 'investment'. It seems that many governments have been pouring money into investment for many years. Despite that, income has just fallen, and the income is not enough to cover expenses, such that government needs to borrow more to 'invest'. In fact, it seems that, the more the government invests, the more it seems to need to borrow in the future for further 'investment'.

What kind of 'investment' is this? With this scale of borrowing for 'investment', at some point in the future our income should be going through the stratosphere. However, it seems that all this investment just means that, at some point in time, we will have to pay back ever larger amounts of money, and there is no prospect on the horizon of our income increasing.

Greece has led the way. Their government's position is the likely future position of the major debtor governments across the developed world. When the credit ran dry, they were faced with no choice but to implement austerity measures. They are now moving onto the road to paying back the gargantuan sums that they borrowed to bribe and delude their electorate. Likewise, in Ireland, and Lithuania, a similar story has unfolded.

Even with the stark reality of the consequences of excess government debt is placed in front of us, it still seems that the reality will not apply to us. Greece is different, as it can not become more competitive with a currency devaluation. Apparently, that solves the problems. We can all just devalue our currency, and all will be well with the world. I have read this so many times that I simply despair.

A currency devaluation is not a solution, it is simply an indirect form of impoverishment. It is a form of impoverishment that hurts savers, and creates a wage cut across an economy. If we think of an average person, who has a taste for imported Belgian beer, we can see why this is the case. He drinks ten bottles of the beer per week, at a price of £2 per bottle, thereby spending £20 of his income on Belgian beer. After the devaluation his cost for Belgian beer increases to £2.50 per bottle. This means that his expenditure for identical beer has increased by £5 per week, meaning that, in real terms, he is poorer. If we then think of his savings in Belgian beer terms, he might find that he is even poorer. If we imagine that he has £20,000 in savings, before the devaluation he held the equivalent of 10,000 bottles of Belgian beer. After the devaluation he only holds 8,000 bottles.

In the case of our Belgian beer drinker, he made the error of saving. He gets hurt on the real purchasing power of his wages, and gets hurt for being dumb enough to save money. In reality, a currency devaluation is just a wage cut over the economy, and a wage cut that hurts those who have been prudent enough to save (investors).

Devaluation also hurts the overseas investors who have been foolish enough to have put their money in the economy in which the devaluation takes place. In their case, we can think of their investment again in terms of Belgian beer. As with our domestic saver, they put in the equivalent of 10,000 bottles of Belgian beer, but when they take their money back out, they find it is only worth 8000. Sure, they can buy the same amount of English beer as before, but why should they endure being poorer in Belgian beer terms? They invested in good faith, and find that they are poorer.

Apparently, countries like the UK are 'lucky' that they have the freedom to devalue their currencies. I would suggest that the politicians are lucky that they have the freedom to devalue, as it is a method of cutting wages and paying for their past profligacy without actually having to admit that the fault is theirs. They do not have to face their people and tell them the truth, which is the (partly) case in the Euro countries.

I say 'partly', as even when confronted with reality, they instead blame 'speculators' and the evil money men in the markets. 'Yes', there are some who profit from the plight of countries like Greece, but that is not to say that the problem is their fault. It is only because the politicians spent like drunks that the speculators are in a position to profit. These 'evil' investors need the foolishness of governments, or their speculation will come to nothing. What happens is that cause and effect are rearranged. It is not the strength of the speculator's position that allows them to profit, but the weakness of the government's position. In other words, it is the government that is the cause, and the speculation that is the effect.

The trouble is that many analysts and commentators are apologists for this line from governments. In doing so, they distract from the real source of the problem, which is that governments have acted irresponsibly.

In practical terms it is very simple. As a contributing part of society, a worker pays taxes to pay for the activity of government, including benefits such as health care, social security, policing and so forth. All of these cost money, and the worker contributes a percentage of their taxation to pay for these. If the government provides a percentage of all of these activities through borrowing, then they are in effect subsidising the worker's purchasing power through borrowing. The individual worker has the same benefits, society has the same benefits, but the benefits are being paid in part by borrowing. The problem is that the government claims that it is the government that is borrowing the money, when in reality it is the worker who is borrowing the money.

The government will not have to pay back the money. The worker will. The government has no income except through the taxation system, and that means that the government is not really borrowing money, the worker is. What we are seeing in Greece is that the Greek people are trying to move to the position of paying back their own previous borrowing, which was undertaken in their name by their government.

This is what all of the complexity and dissembling is about. Governments borrowed the money in your name, and pretended that the debt was their own. They lied to you. They pretended that the debt was not yours, but it nevertheless belongs to you. It is not the government's debt, it is your debt. Whilst everyone talks in the abstract about government debt, as if it were something separate from the tax base, it is not something separate. Every penny of borrowing is, at some point in time, going to be paid back by people like you.

Sure, again we will see governments dissemble. They will try all kinds of methods to reallocate the debt, for example pouring high taxation onto corporations, or singling out group 'x' or group 'y'. All of this will be done to hide the fundamental problem, which is that they never should have been borrowing in the first place. If group 'x' or group 'y' are such good causes for higher taxation, why was it they were not taxed so highly before? They could have been taxed before, as there was no reason not to, and the debt would have been avoided. Instead, the government will now paint group 'x' or 'y' as deserving of higher taxation with populist rhetoric. At no point will the government ever explain why group 'x' is so deserving of taxation now, when they apparently were so undeserving of such taxation before.

And the commentators and the general public will eat it all up. The government will carry on as governments do, and the inevitable pain will nevertheless take place. In the end, the point of this post is simple. When the pain does come, do not be distracted. Put the blame where it lies. It lies with the government, and with the apologist commentators and economists who have sought to justify the great lie; that government owns the debt, not the taxpayers.