Wednesday, 23 February 2011

The crucial importance of foreign bond holders in relation to the U.K.’s deficit and austerity.



According to the Financial Times, Mervyn King in a speech in Newcastle said “households would have to accept a period of austerity because of the need to raise consumption taxes and cut spending to bring the deficit under control.”

Mervyn King actually said nothing of the sort. But then our so called quality broadsheet newspapers have never been vastly more reliable sources of news than Playboy magazine or Asian Babes.

However a large majority of OTHER economics commentators ARE saying something similar to what Mervyn King allegedly said, namely that cutting the deficit requires increased taxes and/or government spending cuts, which allegedly brings austerity.

This is nonsense. I’ve been banging on about this myth for best part of a year now. For the umpteenth time here is the flaw in the flaw in this “austerity” argument.

Reducing the deficit simply involves getting taxpayers to fund a portion of government spending rather than lenders (i.e. those who buy government bonds). And there is no more reason for this to be deflationary, or to involve austerity than switching the tax burden from income tax to a sales tax. (As opposed to tax increases, public spending cuts can play a part, of course.)

A slight problem with this “switch” is that might seem to involve switching the tax burden from the rich onto the poor. But this “problem” can always to dealt with by altering income tax and/or other wealth based taxes.


Foreign bond holders.

There is however a reason why reducing a deficit MIGHT involve austerity. If the portion of national debt held by foreigners has been rising in recent years, that is an effective subsidy of living standards in the country concerned. And if that subsidy were to suddenly stop, that would cause what might be called a standard of living hit or “austerity”. But does ceasing to live on an ever expanding overdraft really constitute “austerity”? Isn’t it more realistic to call this “facing reality”?

This foreign bond holding point is significant for the U.K. The U.K.’s national debt has been rising at a rate that equates to about 6.6% of GDP a year. See here and here.

While the proportion of this held by foreigners has risen by about 50% in the last three years or so (from 20% to 30%).

And those numbers are significant. They equate to a standard of living subsidy amounting to about 2% according to my highly questionable calculations. ((6.6/5) x (30/20) = 2))

But ceasing to rely on foreigners funding an ever expanding national debt is no reason for job cuts or increased unemployment. The only reason to cut employment levels is the threat of excess inflation. That has nothing to do with the deficit.

Moreover, the U.K. seems to have got used to “austerity” so far as living standards go. As Mervyn King said in the above speech “….in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.”

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