UK Finance News

The following post is from the Libertarian Alliance director Sean Gabb. We do not necessarily agree with the views, but consider it worth publishing in full as an alternative view on the expected proposals to be made in tomorrows budget announcement to stave off recession.

The British Government’s Tax and Spending Proposals:
Testing Keynes to Destruction (Again!)
by Sean Gabb

Tomorrow afternoon, all the journalists have been primed to say, the
British Government will cut taxes and increase spending. The alleged
purpose of this is to prevent a deep recession. The real purpose, there
can be no doubt, is to win the next general election for Labour – and,
since the Conservatives remain as useless as ever, it may well work. I
will, however, discuss the alleged purpose. Politics aside, it will be
about as catastrophic a response to our current troubles as can be
imagined.

The politicians of every party, and every journalist I have read, are
agreed on the nature of these troubles. The crises of the past year in
the banking sector have caused investment to fall. Consumption is now
beginning to fall. To use the Keynesian jargon, aggregate demand has
fallen, or is falling, below the level needed to keep national income at
its full employment level. The answer is for the Government to cut taxes,
thereby encouraging people to spend, and to increase its own spending.

It is also agreed by all that interest rates should be cut, thereby
encouraging people to spend still more and encouraging firms at least to
go back to investing as much as they were until the troubles began. It is
admitted that doing all this might cause other problems. But this
admission is followed by warnings about the horrors of the deflation we
otherwise face.

This kind of economic reasoning is not as worthless as some of my friends
believe. In countries as heavily regulated and corporatised as modern
Britain and America, an increased preference to hold cash will not be
balanced in the short or medium term by changes in the structure of
relative prices. Firms will cut production rather than prices. Trade
unions will prefer job losses to wage cuts. This can mean a very long and
severe recession. There can be little doubt that, regardless of whatever
would have followed, even without the Second World War,  the currency
debasement of 1931 moderated the effect here of the Great Depression.

However, while not entirely worthless in certain conditions, what we are
now being told is entirely worthless now. There is no doubt that people
are spending and investing less than they were, and that they will
continue to spend and invest less for some while to come. But, before
agreeing that the politicians should be allowed to do what they most
enjoy – namely, spending money that is not their own and that often does
not yet even exist – we need to ask why we are in such trouble. The
answer will explain why the proposed response will be catastrophic.

For many years, interest rates have been held below the sort of level
needed to balance the supply of savings and the demand for loans. The
result has been inflation. That many consumer prices have been falling is
no argument against this proposition. Inflation is best seen not as price
increases but as monetary expansion. There was a time when monetary
expansion led fairly soon to price rises. Where at least Britain is
concerned, though, most consumer goods are imported. So long as
foreigners are willing to finance a growing current account deficit
without devaluation, demand for imported consumer goods can expand
rapidly and for years without any increase in prices.

The new money will therefore be used partly for investments in new
production that may or may not be wise in the long term – and also to bid
up the prices of property and of paper assets.

These bubbles never last. There comes a point where people lose faith in
a currency, and where the upward spiral of asset prices is checked.  The
fall in the currency will push up consumer prices. Overvalued assets will
fall in at least real terms. Many other investments will be shown to have
been unwise. The immediate reasons for their bursting are less important
than that they always will burst. This has now happened. There is no
definite rule in these matters. But it seems that the length and
intensity of the boom is roughly in proportion to the scale of the
recession that follows.

The financial collapse we are now witnessing, therefore, should not be
seen as some autonomous fall in aggregate demand that can be offset by
increasing other variables in the national income income equation. It is
instead part of the unavoidable correction to past experiments in demand
management. All the clever people disagree. They do believe that playing
with aggregate demand can avert, or at least moderate, the coming
recession. Now, these people are often very clever – most of them more so
than I am. They are still wrong.

Cutting taxes is always a good idea. Not balancing them with spending
cuts is not so good. If the British Government will do tomorrow what the
journalists say it will, the inflation will be continued, though now
without the confidence in sterling that allowed it before last year to
create the illusion of prosperity. Taxes will fall. Government and other
spending will rise. Interest rates will be cut. In the short term, this
may be enough to win the next election for Labour. It not even before,
though, the pound will collapse shortly after. Interest rates will then
need to rise sharply, if the Government is to continue selling its bonds
and if consumer prices are not to rise sharply and continuously.

There is no reasonable chance of deflation. For the next few months,
while the collapse of sterling is only gathering momentum, firms will be
able to reduce prices to keep up demand for their products. This will
give the appearance of deflation. Eventually, though, their margins will
not be further reducible, and the collapse of sterling will raise costs
that must be handed on. This will happen even without further action. The
bank rescues of last month were financed by money creation that will,
sooner or later, find its way into circulation. Deflation is the last of
our worries.

I have no professional expertise in finance, and so give no warranties of
any kind. This being said, I think it a good idea for anyone who has a
mortgage to get the best fixed rate he can between now and Easter, and
otherwise to avoid saving money at any rate fixed longer than six months
ahead. If he wants to buy imported consumer goods, he should do so now
or, at latest, in the sales after Christmas.

Beyond this, I have no advice. Just because I do not believe in the
solution that everyone else is urging on us does not mean that I have any
alternative solution to offer. We should never have got ourselves into
this mess. Failing that, the recession should have been allowed to hit
last year. Since it was then deferred, it should be allowed to hit now.
It will do nothing to moderate the inevitable recession. But there is a
good case for cutting taxes and government spending now by at least a
third, and then by five per cent a year every year for the next decade.
And there is a case for returning to a fully convertible gold standard.

Of course, no politicians will take my advice. If any do read what I have
just said, they will at best laugh with contempt. But I am right, and I
feel some grim satisfaction in being able, come 2010, to send this
article out again under the heading “See – I Told You So!”.

–
Sean Gabb
Director, The Libertarian Alliance
sean@libertarian.co.uk
Tel: 07956 472 199
Skype Username: seangabb

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