economonkey

The Laffer Curve is a description of the theoretical optimum point of taxation rate on a population. It implies that there’s a ’sweet spot’ of taxation where the most income is generated for government coffers. Set the taxation rate too low and the government misses out on potential revenue. Set it too high and an [...]

This is an article that I could have written a few months ago, when the Bank of England stated its intention to begin ‘queasing’. But it has become rather more relevant now that one of the pronouncements of the G20 summit is that the International Monetary Fund (IMF) will itself begin to ‘print’ additional SDRs (Special Drawing Rights, effectively the IMF’s own currency) which its contributor countries can draw down in the shape of dollars, euros, etc.

Note my use of the word ‘print’ in the above paragraph. The days when first world countries used the printing press to increase the volume of money in circulation have long gone, assigned to eras such as Weimar Germany. Paper and ink are still heavily in use in Zimbabwe, of course, but for countries like the UK, where the notes and coins in circulation account for only about three percent of the total ‘money’ in the system, we’re really talking about digits on a computer screen.

Even so, while the phrase ‘quantitative easing’ sounds nice and strategic, in reality it has a similar effect to printing addition bank notes and throwing them out of the Bank of England’s window into the street.

To take a step back for a moment, let’s look at the main blunt instrument used by policy-makers to control the velocity of money and the rate of growth of an economy: interest rates. Set the base rate low, goes the received wisdom, and people will ‘invest’ their money rather than leaving it idle in a bank account earning nothing (or, depending on the level of true inflation, less than nothing). If the economy starts to run away from itself and bubbles form in a particular investment market, interest rates can be raised, increasing the appeal of saving and reducing the relative gains to be made by investing in speculative markets.

I’ve been waiting to finish this article until the UK’s inflation figures were released. They show the CPI figure for November to be 4.1%, higher than predicted by the majority of economists. This figure is more than double the 2% target that the Bank of England’s Monetary Policy Committee is supposed to aim for, yet [...]

I’ve written in a previous article about the various concepts involved in economic inflation and how it can affect the value of your money, your wages and the things you buy.

The opposite of inflation is deflation, which I’ll explain in this article before going on to discuss the probable and possible situations in the UK for the next few years. The ‘deflation versus inflation’ argument is more important in the UK today than it has been at any time in the last 30 years, so it’s worth thinking about in some depth.

So, deflation. If inflation is a general increase in prices and/or wages driven by the greater availability of money (whether ‘real’ money or debt), then deflation is a general decrease in prices and/or wages driven by the much reduced availability of money. This is widely considered to be a bad thing.

But isn’t a reduction in prices a good thing? At a simple level, yes it is. Your wages – assuming they aren’t cut at the same rate – go further, your savings buy more over time and there’s less of a ‘treadmill’ effect where people feel that they are working ever harder to chase money to buy the same purchases, as happens in inflationary environments.

But politicians and economists fear deflation for a good reason. Fundamentally it stops the economy dead in its tracks. Nobody will buy something today that they don’t really need if they know it’s going to be cheaper tomorrow. This applies to companies as much as to individuals, which means that investment stops, companies cut back their staffing levels and unemployment rises. We end up with a deflationary spiral that’s every bit as traumatic as a highly inflationary one.

Deflation also makes it harder to pay off the principle amount of any debts, because wages tend to go down in nominal terms but the amount owed remains the same. This, incidentally, is why some newspaper pundits are now calling for deliberate inflation in order to wipe out the value of many people’s (and the nation’s) ill-advised debts, though such pundits are ignoring several important points about the banking industry’s methods of counteracting inflation through charges and wider interest rate spreads.

(or “Stop talking us into a recession!”)

In recent months I have read, in newspapers and online forums, and heard, from some genuinely interested people and a few incurable optimists, the proposition that the problems in the financial system are somehow due to ’scare-mongering’ in the press. Depending on your bull/bear persona, it’s easy to agree or disagree with this proposition without actually thinking too much about what it means.

So let’s take a step back and consider the fundamentals. First, the mass media obviously influences public opinion. There can be no doubt about that. If it didn’t, it wouldn’t exist; it would have no political role and no advertisers would be interested in paying to be a part of it. Television and newspapers have finely-honed psychological hooks, and although they’re suffering because of the accessibility of more credible information on the Internet, they know how to drag their readers in with a good, emotional (but seemingly rational) headline and story.

As we know from experience, when every newspaper and television channel is exhorting people to buy into the housing pyramid scam (sorry, market) because ‘house prices only go up’, and using fear and greed to push that message home, it has an effect; first on the psychology of the public and then on the market pricing.

In the UK the government has a system called the Financial Services Compensation Scheme designed to protect savers’ deposits in the event of a bank collapsing, which seems to be happening every other week at the moment. If a bank, building society or credit union goes bust, the government will refund your money within certain [...]

In my previous article I described the remit and practical activities of the Bank of England, as they relate to the operation of the UK economy. Now it’s the turn of the Treasury (or HM Treasury, to be accurate), which is the part of the government that looks after the UK’s money – most of it raised through taxes – and, to a large extent, decides how and where it should be spent.

The first fallacy to blow out of the water here is the idea that taxes collected in a particular sector are also spent in that sector. For example, it would be nice if road tax revenue was spent on improving the transport system, wouldn’t it? Or if levies on the oil industry were used to promote renewable energy sources.

Well, they aren’t. Such so-called ‘hypothecation’ of taxes would be complex to administer, though arguably it would help people feel that their hard-earned cash was being used for something practical rather than, say, lining the pockets of MPs who fancy a second house in London. For example.

Instead, all revenue collected by the government goes into a large pot which is then doled out in accordance with plans drawn up by the Chancellor of the Exchequer (currently old badger-brows, Alistair Darling, and previously Gordon ‘Prudence’ Brown).

Although most people have a rough idea of how the UK economy works (or, if you’re being cynical, doesn’t work), the functions of the various components and their relationships to each other can be quite elusive. We’ve covered some aspects of money on this site in the past (here, for example), but there’s more to the economy than money itself. In fact, arguably more important than money is the way in which that money is moved around the economic system of the UK.

Over the next few articles I’m going to look at each of the main institutions involved in the movement and management of money in the UK. I’ll be looking at the Treasury, the FSA, the City of London as a whole and, to start with, the Bank of England (you may have spotted the one glaring hole in this list, more important than all the rest, which I’ll cover at at a later date).

The Bank of England is not a bank in the traditional sense. You can’t deposit your money there directly, and nor can you borrow from it directly. Banks, however, can. This is the fundamental aspect of one of the Bank’s stated core purposes: to maintain financial stability in the UK economy. By lending to banks that are suffering from cash-flow problems, unusual circumstances or moronic management, the Bank can act as a buffer to prevent problems in one area of the economy spilling over into others. Hopefully.

To quote from the Bank’s own documents: “Financial stability entails detecting and reducing threats to the financial system as a whole. Such threats are detected through the Bank’s surveillance and market intelligence functions. They are reduced by strengthening infrastructure, and by financial and other operations, at home and abroad, including, in exceptional circumstances, by acting as the lender of last resort.”

You may feel a hollow laugh coming on at this point, given the last year’s experience of a crumbled, nationalised bank, a bursting bubble of overpriced housing, rising inflation – especially in food and fuel – and incomes that fail to match expenses. It doesn’t look much like financial stability, does it?

Sooner or later, when considering decisions about money, you will come across the Vested Interest. In fact it’s almost impossible to avoid them. A Vested Interest (VI for short) is a person, company or organisation that wants to get its views across in order to somehow influence the people who are reading, watching or listening to them. ‘VI’ may be used to decribe the entity itself or his/her/its viewpoint.

Some VIs are obvious, some less so. I have a VI in writing this article. I’m hoping that if I make it interesting enough, and the information contained within it useful enough, more people will read it and so the traffic to this site will increase and hopefully at some point we’ll be millionnaires. Actually, it would be nice if we could make enough money for a cup of tea once a week, or perhaps cover the hosting fees. So my VI is quite transparent and, I hope, harmless.

But that is rarely the case once you get into the mainstream media. As Piers Morgan and his tipster colleagues at the Daily Mirror proved a few years ago, the temptation to use a position of public influence to push your own agenda can be overwhelming. And it’s not always illegal, either, though one might argue that it should be.

For example, of all the possible investments, the property market is not regulated by the FSA. Any idiot can call themselves a ‘property expert’ and give what is basically unregulated financial advice. And many of them have. Media people are among the most likely to be amateur landlords, so it’s not particularly surprising that the television schedules have been riddled with programmes extolling the virtues of ever-increasing property prices over the last decade. Nor are newspapers immune. The Times, for example, has carried a lot of property advertising, and has columnists who seem to believe that ‘house prices only go up’ – coincidence? Maybe.

Identifying Vested Interests will help you to decide for yourself whether a particular article is truly impartial – or as impartial as it can be – or whether you should treat it as wishful-thinking fiction. The following selections reflect my personal experiences with the media outlets concerned and are opinions only. Your mileage may vary, as they say.

I am writing to enquire whether you have any vacancies on your strategic board for someone of my talents. I realise that it is a little unorthodox to apply ‘on spec’ for such a high-ranking position within your organisation, but I believe I have the necessary skills to further increase the profits and assets of Big Bank Plc. In this letter I will attempt to demonstrate my knowledge of the challenges and opportunities in our marketplace.

1) Who are our customers?

I understand that our most lucrative customers are those with the least awareness of financial matters; indeed, the less numerate they are, the better. Rather like the dear old PM, in fact.

If they don’t know the difference between APR and AER, if they fail to read the small print in their credit contracts – not that it matters, as I’m sure I have the necessary legal skills to make such text impenetrable – and if their limited attention is grabbed by an ‘introductory’ rate, then they are exactly the kind of people we need to target.

I think that if we closely follow that other highly successful model of commerce – drug dealing – we won’t go far wrong in attracting and retaining the right customer base.

2) How do we get people to take on more debt?