A reader writes in response to the UK government's VAT rise:
The government has to borrow money throughout the year in order to be able to pay for public services and debt repayemnts. The way it does this is by selling bonds. These are I Owe You's written by the treasury, a bond trader buys a bond for say ten ponds, after say 5 years the government will pay them the ten pounds back plus a certain amount of interest. The amount of interest that the government has to pay on these loans is dependant on how popular the bonds are to the bond traders, it is a market, risky bonds will require a higher interest rate than rock solid bonds.The real danger of the bond market for the economy is that it will turn against a certain currency. If the interest charges on bonds rise so much that governments tax receipts are unable to pay them off then a country is in real trouble. This has already happened in Greece and Ireland. I believe it was the bond market turning that also triggered Britain to have to leave the ERM in the 1990's. So what causes the risk of bonds to increase, i.e. what makes their interest rates rise. As I understand it there are 2 things that could really spook the market.Firstly if a country defaults on an interest payment-If you invested in something where there is a chance you might not get your money back you would demand a bigger reward assuming they are able to pay you back. In UK because we have complete control over our currency (unlike countries in the Euro Zone) we would probably never default on a loan, we would just print some extra money and use that to pay our debts. Unfortunately that could then lead to a second danger of high inflation. So what is high inflation. If I lend you 10 pounds and you offer to pay me interest of 10% over a year for that loan i might be happy. If after that 1 year my 11 pounds (10+1interest) can only buy something that a year earlier only cost 8 pounds I have infact lost money. I put away 10 pounds and now it is only worth what 8 pounds was.So is this a real risk in the UK or is it just an excuse for the Tories to cut the cost of government? Having watched numerous debates it seems clear to me that it is a danger. BBC Newsnight debates often talk of the PIGS (portugal,Ireland, Greece and Spain)which are the most overstretched economies in the Euro zone. Greece and Ireland have already had to have EU and IMF bailouts basically because they went bust - they could not afford to pay pay their debts. It is often stated that after Portugal and Spain, the UK is one of the most indebted economies and could be the next in line. The result of a bond market revolt seem pretty serious, How lightly that it is to happen to the UK is I guess more debatable.
While I don't disagree that the debt crisis is real and serious, I do disagree with the methods the Tory government is using to address it. Many countries have used austerity measures to combat recession with dire results - Chile stripped away the functions of the state in the early 70's under the tutelage of neo liberal economists from Chicago with disastrous results. Chile went through a prolonged bout of stagflation, inequality spiralled out of control and there was huge unemployment that the government was incapable of controlling. A good article on the Chile experiment can be read here. Margaret Thatcher also applied the same measures to Britain in the early 80's with similar results - mass unemployment, declining wages and unprecedented inequality.
The Tory party's obsession with deficits and inflation goes way beyond the rational. The cuts they are making will make growth for most of the economy extremely difficult - cutting welfare, slashing public sector jobs, freezing pay and raising VAT etc will not encourage economic activity in the slightest. George Osborne's ridiculous assertion that the VAT rise is 'progressive' is simply laughable, and they should be deeply ashamed of themselves.
The fact is, the Tory party is cutting the deficit on the backs of the poor and middle classes. While the rich are getting a gentle tap on the wrist, everyone else gets raked over the coals. And the worst thing about it is government spending was never the issue in the first place - it was the massively irresponsible behaviour in the City that caused the economic meltdown, not excessive welfare or overly generous public sector pay.
Yes, the country needs to cut the deficit, but it needs to do so by creating a plan for growth and taxing those responsible for the crisis in the first place. That would be fair, and according to economists who actually predicted the crash, it would also work.