Nowadays, most countries run large budget deficits. We have been accustomed to this state of the country’s finances. In my native France, there have been no balanced budgets for the last 40 years!
In the UK, where I reside, the budget deficit is slowly slipping down the topic order for the upcoming general elections. Yet, the government is borrowing this year another £80bn to plug the gap. If you do not know how big a billion is, read this.
In some countries, governments routinely spend 20% more than what they collect in taxes. Imagine having these finances! And yet, most voters do not seem to either realise or care.
More futile topics are crossing the minds of the men and women on the street.
For instance, I have used Google trend analysis. I am pitching the search “budget deficit” with something equally large: Kim Kardashian (assuming many searches will relate to her bottom).
While I do not know if Kim’s bottom is getting bigger, it is quite telling that it generates a much larger interest than the budget deficit.
The good point is that the general public likes to concentrate on big bulging issues. Let us try to get them to look at monetary bulges. The budget balance is one of the most important economic principles.
Think of the following statement: one needs savings for growth. Is this true? Does this matter? If you look at your personal case, it sounds like common sense: to buy a house, you need a deposit. To gather a deposit, you need to save the money (or ask dad, but dad also saved it in the first place).
Assume now that this can be expanded to the whole economy. If we require savings to generate growth, then the producers of a whole nation need to generate more wealth than what is consumed or taxed so they can have some little extra to invest for the future.
Think of having to pay all your bills and having something extra for the rainy days.
When the government continually borrows money to pay for spending, it actually cannot save money to invest in the future. It actually finances today’s programmes at the expense of tomorrow’s products.
Only two outcomes exist:
- The producers in the economy will generate so much more wealth such that the government will receive higher taxes to pay back all the borrowings
- Growth or the rate of growth will drop as the government taxes away the wealth of existing producers.
In case 2, if the government continuously operates a deficit and spends what does not exist yet, this will eventually lead to a financial disaster.
Let’s take an example: Greece
Even before the financial crisis, the Greek government was already operating at a large deficit constantly.
No wonder that now that the economy is contracting, this is only getting worse despite the Greeks cutting spending. It was simply too late.
There is a school of thought saying that the problem in Greece was tax collection, not spending.
I am not going to enter a debate in particular about this, but the gist remains the same: if you operate a large deficit constantly, at some point, someone will protest. Even if you are the US – think 2008.
Why does this matter to my savings?
It may not matter right now, however it is interesting to keep an eye on the budget performance of your country of residence.
If your country is operating regularly at a deficit during good or decent times, it is at high risk of having a budget accident when the economy slows. When this happens, risky assets (think shares, property, some riskier bonds) will see their value fall markedly.
If you need to use your portfolio at this point, you will have to take large short term losses.
Take the 2012 Cyprus banking crisis as an example.
Cyprus, as an economy, is tiny. The country itself is pretty rocky, with little agricultural or industrial facilities. However, Cyprus is in the EU. If you operate in Cyprus, you can passport your activities legally and without too much hassle everywhere in the EU.
Therefore, a large banking system developed and a majority of depositors were Russian individuals and corporations. Indeed, once your money was in Cyprus, it was legally in the EU. Nice!
Many Greek banks had subsidiaries in Cyprus and locally, a few local banks were operating.
These banks received deposits from the Russians. Instead of letting them sit idly in their vaults, they lent some of them (but remember, there is not much to invest in in Cyprus) and invested the balance in what sounded like safe securities: bonds of the Greek, Italian, French governments.
Eventually, Greek bond investors had to suffer horrific losses, of up to 70%.
Therefore, Cyprus banks lost a portion of the deposits of their clients by being invested in the wrong securities.
In fact, they lost so much money that they were on the brink of collapse.
Normally, in this case, depositors are relatively protected and their savings can be returned to them.
This time, the EU invented the concept of “bail-in”: above a certain sum by depositor (€100,000 in the EU), the failed bank can use your deposits above €100,000 to reimburse creditors.
This means that you can be quickly in a situation where the failed budget policies of your country can engulf your banking and saving system.
If trust drops, then the consequences can be dire:
Therefore, as many countries continue to operate large deficits and have no clear plans to return to budget balance, the odd of yet another financial crisis are increasing day after day. We cannot pinpoint a trigger yet but the root cause will be the same: too much of the wealth being produced is taxed away and not enough is left for reinvestment in future opportunities.
Think of your own finances as you think of the economy. With no savings and ever higher debts, you cannot make plans for the future.
George Osbourne, UK Chancellor: let’s hope he does stick to his deficit reduction plan.
I am not recommending voting for any party in particular. But I am inclined to vote for a party which has the very principle of sound public finances on its platform.
Sadly, these parties are rare.
What a French finance Minister balancing the budget looks like. One became president so it is not a career-killing activity.
Kim’s bottom. Safe for work (SFW).
Interestingly, she is rumoured to have had implants injected in her bum to make it bigger so she would get more attention. She has invested in the future with some of her earlier savings. The US government is benefiting from her larger bum via the taxation of her bumper earnings.