Friday, 14 October 2016

Balance of Trade

What are the consequences of Britain running a prolonged trade deficit? 

     I recently asked myself "Why tax?". Why not run a prolonged fiscal deficit, in which the government makes up the shortfall by printing new money[1]. Now I ask the question above: "What are the consequences of Britain running a prolonged trade deficit?"
     It is today a simple matter to find data on the web for Britain’s trade balance from 1956 to 2016 [2]. These show an approximate balance until the mid eighties, but a period of 6 years from 1986 - 1992 where the balance of trade and services went extremely negative. Balance was restored quite rapidly and remained in balance until Labour came into power in 1997, whereupon there began a progressive slump into negative balance of trade and services. From 2004 to the present we have been running more-or-less steady at a deficit averaging 3.2 B£ per month (B£40 per year). That is around 2.2% of GDP, but it fluctuates month by month. 
     A somewhat grimmer picture is seen in what the Office of National Statistics (ONS) calls the 'current account deficit' a figure which, in addition to the balance of trade and services, includes profits on our British investments overseas minus the profits in this country repatriated to other countries. In the second quarter of 2016 the 'current account deficit' reached 6.9% of GDP[3]).
     I posed myself two questions: (a) by what mechanisms does the market correct itself? and (b) why is there a lag before correction? If I (like many UK citizens) want to buy a German car, I can offer £ or buy € and offer that. If the seller wants €, my purchase will depress the exchange rate. But if the seller prefers he can accept the £, and use them to buy gilts, bonds, or real estate in the UK. 
     I suppose there was a period of years during which foreigners were prepared to trade in £ and leave their winnings in the sterling area. The £ (for some obscure, and maybe irrational, reason) traded at a higher value than it should. That foreign money now seems to be leaving. The pound is relaxing and the skewed balance of trade should soon rectify, with us all 6.9% worse off. 

Do please comment if you think I have got this wrong.

References
[2]  http://www.tradingeconomics.com/united-kingdom/balance-of-trade
[3]  http://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/timeseries/hbop/pnbp

Friday, 7 October 2016

Why tax? Why not just print money?

Why tax? Why not just print money?

     It seems [1] that the business of balancing Government spending and tax revenues is not quite so crucial as many of us have supposed. A fully sovereign government can simply make up the shortfall by printing fresh money. Could it perhaps abolish taxes altogether? I mean, just print the money it needs to do what governments do. 
According to Wren-Lewis [2] “there is a growing consensus that monetary policy and not fiscal policy should deal with macroeconomic stabilisation (Kirsanova et al, 2009)”.  It is certainly true that there has been much tweeking of ’Bank Rate’ in the last 50 years, and it is also true that the novel procedure of ‘quantitative easing’ has been used vigorously in the USA, UK and the Eurozone since the credit fiasco of 2007/8, in an attempt to stabilize or revive the macroeconomy. But, in the last year, that trend seems to be waning, perhaps because you cannot lower interest rates effectively when they are already at zero, and quantitative easing seems to be about as ineffective as pushing on a piece of string. (The Bank of England gives some money to the banks, and all they do is place it on deposit back with the Bank of England [3], even though interest is near zero percent.)  Finally this autumn there is talk, first from Labour [4] but then last week also from the Tories [5], of abandoning ‘small-government austerity’ and using Government spending as a way of boosting the economy. Does this mean that the ‘growing consensus’ of Wren-Lewis is dispersing?
    A sovereign government with a floating ‘fiat’ currency can print as much money as it needs. There is talk (by Wren-Lewis) of ‘Modern Monetary Theory’ having its inception in 1971 when the USA came off the gold standard.  As analysis of the theory behind a floating ‘fiat’ currency seems to date from 1905, the term ‘modern’ must mean something like ‘incompletely understood’. However, it is becoming increasingly clear that countries with sovereign currencies (as UK and USA) do not need to maintain fiscal balance; they can spend more than they raise in taxes, can run a deficit, year after year after year. Indeed (according to the ‘modern theory’, though this is far less widely understood, and may have missed George Osborne completely), they must run a deficit if the economy is to grow. Wikipedia puts it rather starkly: government deficit puts money into private pockets, government surplus takes it out. (This deserves a post on its own — later.)
I examined, in a previous post, the beneficial effect on GDP of raising  taxes [6].  Here I toy with the possibility of completely abolishing taxes, lowering tax rates to zero, running the entire cost of government by printing money. 
Suppose (and these are realistic figures for 2015) UK gross domestic product (GDP) to be 1,864 B£ [7]; total government receipts from tax and national insurance contributions to be 515 B£ [8]; and the total (broadly defined, i.e. M4) money supply to be 2,115 B£ [9]. The proposal therefore is to introduce new money each year to the tune of 515 B£. This would increase M4 from 2,115 B£ to 2,630 B£ in the current year. In simple monetarist terms this rise of 24% would be expected to cause inflation of the same amount. 
Inflation, of course, takes money off everyone who has it, and in proportion. It is a tax on cash savings. If I owned a house ‘worth’ a million in 2015, in this scenario I could probably sell it for £1,243,500 in 2016, but its worth would not have changed. However, if I had a bank balance of 1 million, it would still be £1,000,000 the next year, but worth only 80.4%, or £804,000 in ‘old money’. People would soon learn to spend their cash as promptly as possible. The ‘idle rich’ (Keynes’ Rentier class) would not like this regime; but the rest of the population might. Central banks aim at an inflation rate of 2%, so 24% does seem steep, but there must be some other reason for taxation, apart from the fact that governments have always exacted tribute off the weak. 

References

[1]  https://mainlymacro.blogspot.co.uk/2016/09/why-was-austerity-once-so-popular.html
[2]  https://www.bsg.ox.ac.uk/sites/www.bsg.ox.ac.uk/files/documents/BSG-WP-2016-014.pdf
[3]  http://occidentis.blogspot.co.uk/2015/01/candidate-mps-if-i-am-going-to-support.html
[4]  http://blogs.spectator.co.uk/2016/09/full-speech-john-mcdonnell-labour-conference/
[5]  https://www.theguardian.com/politics/blog/live/2016/oct/05/theresa-may-speech-tory-conservative-conference-theresa-mays-speech-politics-live?page=with:block-57f3eb44e4b0afec6ad16cb6#block-57f3eb44e4b0afec6ad16cb6
[6]  http://occidentis.blogspot.co.uk/2016/07/tax-and-spend.html
[7]  UK GDP (nominal) 2015 = 1,864 B£ (1.864 T£). https://www.measuringworth.com/datasets/ukgdp/result.php
[8]  Total UK tax and NIC income (2014-5) = 515 B£; =29% of GDP. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/539194/Jun16_Receipts_NS_Bulletin_Final.pdf

[9]  UK M4 (total money supply) mid 2015 = 2,115 B£  (2.115 Tr£). https://www.statista.com/statistics/320127/uk-banking-total-money-supply/