UK Government Stealth Debt Default Continues at Minimum Rate of 3% per Year
Economics / UK Debt Sep 19, 2010 - 12:00 AM GMTBy: Nadeem_Walayat
This article is part of a series towards an updated UK interest rate trend forecast. The UK government continues to stealth default on its government debt at the minimum rate of 3% per annum, a price that is being paid for by all workers and savers. The population of Britain has been successfully conditioned by successive governments deploying the pseudo science of economics that appears to exist purely to enable governments to psychologically manage the expectations of their populations such as coming to believe that the stealth sovereign debt default trend is good for them.
You may be wondering what am I talking about? What sovereign stealth debt default at 3% ....?
Perhaps I should use the label that the reader is more familiar with for the stealth sovereign debt default trend, that people have been conditioned into accepting to actually be a good thing for them and the economy i.e. INFLATION, as an outright debt default is near impossible as the government can keep printing money and issuing bonds that the Bank of England monetize's via the fractional reserve banking system.
INFLATION is pure and simple THEFT by the government for the primarily purpose of enabling governments to exist in ever expanding size and scope of interference in everyday lives for without INFLATION i.e. in a normal deflationary world, in which big governments would not be able to exist because accumulated debt would INCREASE in value, thus ensuring that large long-term borrowings could not be entertained in an 'normal' deflationary environment.
Yes deflation should be the normal environment for an economy, if it where not for big governments with big ideas on how to stealth tax the populations wealth and spend it on even bigger and usually worthless projects. Another word one could use for deflation is productivity, each year the productivity of workers increases due to innovation and new technologies which means that the price of goods and services should fall as workers become more efficient in their production and thus the value of hours worked increases. Off course this only tends to happen in the private sector as the public sector ironically becomes LESS productive the bigger it becomes as the number of bureaucrats expands exponentially until the economy folds under its weight, as witnessed by the NHS where a tripling in the budget under Labour has basically resulted in a tripling in the number of bureaucrats employed. This puts the economy into a perpetual worsening state as the Public sector displaces the far more productive and competitive private sector both on the large and small scale, for example small local post offices have been closing across the UK due to lack profitability. However many councils have responded by stepping in to re-open some of the small post offices with grants of say £50k a year towards their running costs, therefore no tax paying private sector postal service will ever be able to again step in to provide a service as it cannot compete against a perpetually subsidised loss making local postal service.
So in our topsy turvy government brainwashed world, we are repeatedly told that DEFLATION is bad, if not evil, and that INFLATION is good, something to leap with joy at the prospects of seeing our wealth disappear down the inflationary spiral. Governments love inflation because it allows them to expand the size of the state which is the natural instincts of ALL governments no matter the political party, as once politicians get into office then out goes the ideology that they used to get elected and off they run to enjoy the trappings of the state as they seek to make their mark on history.
You may at this point interject and state that the current UK coalition government is issuing statements left right and centre that it intends on cutting this that and the other to get a handle on the countries public debt mountain! Only one problem, the coalition government is not going to cut the debt at ALL! they can't cut the debt because the last Labour government has ensured that the gap between that which the government spends and earns is unbridgeable, all that the governments can do is erode the purchasing power of all workers and savers in the economy through inflation which devalues the value of the current total debt of approx £800 billion with another £400 billion due to be added, that THIS so called spending cutting government will rack up during the next 5 years which is why the Bank of England and Treasury pump out propaganda on the economy that never matches reality such as that the inflation rate is always destined to converge to 2% in 2 years time. for example if UK inflation compounds to 28% in 5 years time (RPI 5% per annum), then that means total debt of £1.2 trillion would be worth £864 billion in todays money i.e. Little change from the present! Hey presto the budget deficit is gone whilst the debt burden remains constant. But who has paid the price for this apparent miracle? The bond holders, savers and workers by means of inflation AND taxes on illusory nominal economic growth due to inflation.
How Much of your Wealth Has Been Stolen by the Last Labour Government ?
Well for that we have to take a look at the governments preferred inflation measure, the CPI index which despite under reporting real inflation still shows that the Labour government between April 1997 and May 2010 stealth taxed your wealth and earnings to the tune of 28% to give you the illusion of prosperity, whilst all the time enabling the government to go on an unfunded public sector spending spree to greece the palms of those who most likely voted Labour. However the problem is that the greater the debt burden in terms of % of GDP then the greater will be the future rate of inflation, which currently looks set to wipe out another 28% of the value of your wealth during the next 5 years which will be WITHOUT the benefit of illusory inflation linked pay rises.
Savers at this point may argue that they receive interest on their savings or enjoy capital gains on invested assets (despite the financial crash and bankster designed fraudulently investment instruments that result in only making money for the financial institutions rather than investors). The government has thought of that too and steps in with ANNUAL income taxes at the marginal rate on interest at 20% to 40% (depending on your tax band), and capital gains are also taxed. Which ensures savers / investors are going to find it very difficult to prevent the government from stealing your wealth as the system is designed to virtually guarantee that your wealth will eventually end up in the Treasury. On the other hand if there were no inflation then the rate of income tax on interest would not matter as you would always earn more than the inflation rate which is ZERO and neither would capital gains tax matter. Still it gets even better during deflation where due to increasing productivity general prices should fall so the value of your savings even if the rate of interest is ZERO increases, off course governments cannot allow for deflation because they are no longer able to steal your wealth.
UK inflation presently is increasing at an annual COMPOUND rate of more than 3% as illustrated by the below graph with the August 2010 Inflation rate of 3.1% precisely in line with my forecast for 2010 (27th December 2009 - UK CPI Inflation Forecast 2010, Imminent and Sustained Spike Above 3%), with little sign that there is going to be any change to this trend, especially as the stealth debt default inflation mega-trend is required to reduce the real terms value of total debt that is expected to increase by 50%, that's 50% more debt between now and 2015, which does not in anyway match the Bank of England's mantra of 2% inflation in 2 years time, more like 4%+. How are your savings going to survive being devalued and taxed and into oblivion ? How are wages going to be able to buy goods when the average pay rise is just 2% with many wages frozen or being cut ? That is what happens when a country is stealthily defaulting on its debts! Its just that people have been conditioned into thinking that its good for them when the opposite is true!
China Deflation Has Turned Into Exportation of Their Own Inflation Mega-trend
The current situation of negative interest rates remains highly temporary as unlike the Bank of England's repetitive mantra of temporary high inflation some 9 months on, the ongoing surge in inflation is NOT temporary as it is as a consequence of the inflation mega trend that is being fed as a consequence of the rise of emerging markets that are now starting the process of exporting inflation abroad just as for well over a decade they had previously exported deflation abroad as they produced ever cheaper goods that the west consumed, however that has now gone as Chinese workers are starting to demand substantial pay rises of in some cases more than 50%.
Why is this happening now ? Basically because after 20 years of hundreds of millions of Chinese farmers running from their small countryside villages to ever expanding cities to man the factories, China has now effectively ran out of cheap farm labour, in the future Chinese Labour will get ever more expensive and so will the prices of the goods produced in the shops as chinese workers will both be paid more and also thus consume more, either way the west needs to say hello to the China induced Inflation Mega-trend! Well until another country, perhaps India steps forward to take China's place as the worlds sweat shop, though I don't see how India will be able to achieve such a feat under its creaking and crumbling infrastructure.
For investors it is clear, you want to ensure you have a piece of the China domestic consumption pie, that mega-trend will run for at least a decade or two. However for UK consumers it is all bad news, less real disposable income AND higher priced goods in the shops!
Bank of England Ignoring Inflation
In an earlier article I explained at length why the Bank of England is wrong 96% of the time in its inflation forecasts (13 Aug 2010 - The Real Reason for Bank of England's Worthless CPI Inflation Forecasts).
The Bank of England Forecasts are NOT actually forecasts but propaganda aimed at soothing public concerns on the inflation and economic growth fronts by talking the economy in favour of where it wants the economy to be so as to enable the BOE to improve the probability of achieving its set economic targets and goals which would be far more difficult to achieve i.e. to target 2% inflation if it had to be more candid. Additionally admitting to the more probable implies that they are NOT able to do their jobs as it is far better for the Bank of England to be seen to be in error in its forecasting then to have seen high inflation coming but failed to have acted to prevent it.
The fact that the Bank of England is engaged in pumping out pure propaganda should not come as any surprise for basically at heart they are politicians and as with all politicians tend to be economical with the truth, as we shall probably fund that the Coalitions mantra of cuts of 25% to 40% will probably amount to something akin to nominal cuts of less than 5% as we look back at where the budgets stand in 3 to 4 years time against today's spending totals as illustrated by the below graph.
The delusional self obsessed public sector unions are starting to rev up with propaganda against the spending cuts such as wanting to tax the British economy into oblivion as if there are millions of rich scrooges sat on mountains of gold coins. The unions threaten several winters and summers of discontent though in reality the unions no longer have any powers to do so. There is no rational case to maintain a public sector that is at more than 50% of the economy when in reality it should be less than 30% of the economy. All that such a large unproductive public sector does is to ensure INFLATION as the the public sector acts to leverage UP the countries real inflation rate i.e. private sector deflation due to productivity increases + Public sector Inflation due to loss of productivity equals Higher INFLATION.
NHS Bankrupting Britain - Whilst the Unions and the Labour party busily pump out propaganda the debt interest time bomb continues to go off that will double from a cost of approx £33 billion for 2009-10 to £65 billion by 2014-2015 even AFTER real terms spending cuts of 25% have been enacted! Which is why I concluded several years ago that the NHS would kill the British Economy because that is precisely what is now coming to pass (24 Dec 2006 - The NHS is killing Britain as it wastes tens of billions every year ! ) and (03 May 2009 - Privatise the NHS and Save the UK Economy from Bankruptcy) and more recently (11 Apr 2010 - NHS Bankrupts Britain ).
Where has all of the NHS money gone ?
The below graph illustrates how tripling of the NHS budget has disappeared down a black hole, as pay between MP's and GP's started to diverge during 2003 as a consequence of the inept Labour government being hoodwinked into signing up to new GP contracts that were designed to let GP's enjoy 30% per annum pay rises whilst doing less work which contributed to the 2009 MP expenses scandal, which is indicative of how the public sector functions, where more money does not equate to more service because there is no concept of productivity and profitability which can only exist where there is a market for goods and services so providers have to compete rather than be handed blank cheque's to maximise spending as was Labour government policy.
Off course the REAL cuts will be due to INFLATION, which is why inflation exists as a useful tool to trick the populous into focusing on nominal figures, so in real terms many of the budgets will be cut by about 25% over the next 4 years. For instance the NHS is so badly run that just to stand still it requires at least a 6% increase in its annual budget! The coalition government has promised to ring fence and increase the NHS budget by 2.5% per year which amounts to a real terms cut of 3.5% per annum.
Of course the government could introduce real competition between hospitals and GP practices by privatising the NHS and thus make the NHS far more productive. Such as the recent announcement that ALL 150 NHS PCT's will be scrapped and that GP practices will be forced to come together in some 450 competing consortiums. The GP's at this point may be gleefully eyeing the £100 billion annual budget as a means by which much more cash will end up in their back pockets, but the crunch point will come when supermarkets such as Asda and Tesco's start to compete with GP practices with GP surgeries within supermarkets.
At the end of the day the governments favourite answer to demands for spending on public sector black holes such as the NHS is INFLATION. The only question mark is at what point does the market force interest rates higher to enable continuing issuance of new debt.
Bank of England Paralysed By Fear
Since August 2007 when the credit crisis first broke the Bank of England has been in a state of perpetual state of panic, always opting to do nothing rather than something. For instance during 2008 the Bank of England should have been cutting interest rates but instead it kept them on hold at 5% as it remained paralysed by the fear of inflation right up until Gordon Brown announced the first emergency cut on October the 6th 2008 from the Prime Ministers Despatch Box rather than by the Bank of England MPC, following which the Bank of England was instructed to keep cutting interest rates all the way to 0.5% by March 2009 where they have remained.
Similarly the Bank of England during the whole of 2010 has again been paralysed by fear of non existant deflation into a state of inaction, this time failing to raise interest rates as INFLATION has run rampant at above the CPI 3% level for virtually the whole year. This to me suggests that the first interest rate rise will again come when the Coalition government deems it to be politically convenient to do so, rather than in response to INFLATION unless preempted by the markets.
Deflation Delusion Persists
You hear a lot of continuing talk about deflation, however the whole deflation argument is a delusion the reasons for which I covered at length in an earlier article (26 Aug 2010 - Deflation Delusion Continues as Economies Trend Towards High Inflation). Basically deflationists are living in either the 1930's or somewhere in ageing population shrinking Japan. They are not living in either the UK or the USA or much of the rest of the world. Deflation in our fraudulently fiat money printing central bank governed world cannot exist, not whilst governments run budget deficits that continue to pile on ever more debt that demands inflation to erode its real value as already mentioned earlier and the price for which is being paid for by the CURRENT generation not future generations which is another consensus driven myth that exits purely to condition the population into accepting the frauds of deficit spending, debt accumulation and inflation.
Delusional deflationists that populate the mainstream media have been instrumental in ensuring that the likes of the stocks stealth bull market (02 Feb 2010 - Stocks Stealth Bull Market Trend Forecast For 2010) will continue to run for many years because they miss the most fundamental fact that asset prices are leveraged to consumer prices.
Despite the focus of my analysis being on the UK economy, the United States most recent CPI inflation rose by 0.3% in August with the annualised rate of inflation at 3.6% as the mainstream press looks for rear mirror excuses so as to explain what has already happened. So a year on of perpetual deflation mantra instead of US inflation being at CPI -1.1% it is instead stands at +1.1%, where is the deflation ?
Don't worry if the data does not fit then change the methodology as I warned would happen nearly a year ago that once proved to be wrong the deflationists will attempt to either rewrite history or change the definition of what inflation actually is which is precisely what is happening today (18 Nov 2009 - Deflationists Are WRONG, Prepare for the INFLATION Mega-Trend ).
Such as attempting to change the debate from Deflation vs Inflation to Deflation vs Hyperinflation ! When Hyperinflation is the END GAME ! When populations PANIC and loses confidence in the currency and hence dumps it for anything from consumer goods to hard assets, which in our fast moving financial world probably means that hyperinflation would occur within a matter of hours rather than months as Weimar Germany experienced during the 1920's. So hyperinflation is akin to market crashes i.e. something that cannot be forecast as to when it will occur but rather one can protect themselves from in advance of by engaging in Wealth INFLATION PROTECTION strategies rather than following the bankrupting deflationists recs such as parking ones money in cash or government bonds which are guaranteed to lose you ALL of your money as the first signs of hyperinflation would occur in the bond and currency markets, long before prices in the shops soar and the lagging official inflation indices surge higher!
Bottom line - All analysis should be geared towards only one outcome and that is to arrive at actionable conclusions so as to monetize on trends, the only way to achieve this is by putting ones OWN MONEY on the line on EVERY market conclusion, without which you have the likes of the perma gold bears and deflationists who if they followed their own advice would have bankrupted themselves many times over! It is easy to pump out worthless propaganda based on the pseudo science of economics, it is infinitely harder to arrive at an actionable conclusion that is deemed to have a high probability for a positive outcome.
UK Interest Rates and Inflation Risks
So to gauge when UK interest rates will rise, we need to gauge what level of inflation will hurt the coalition government as clearly 3% despite being above the BoE target is not having any impact. Well Inflation is set to spike higher early 2011 to probably above 4% CPI and 6% RPI which after more than a year of temporary inflation mantra, I am sure that financial markets, never mind the general populous will no longer believe as being just temporary, which does suggest that UK interest rates should start to rise during the 1st quarter of 2011 but by not enough to quell inflation which is official government policy of the continuing stealth debt default trend.
I suspect that the Bank of England and Government are gearing themselves up for substantially higher inflation for many years, far beyond the current rate of 3.1% which will come to be seen as period of low inflation as a consequence of the need stabilise public sector debt in terms of percentage of GDP especially if the government expects to achieve its target for debt at 65% of GDP by 2015-16 which I just do not see as being possible, the most probable outcome is debt stabilising at an inflation inducing 71%.
The risk that the Bank of England and Government is running is that the people start to see through the Smoke and Mirrors and realise that persistent high INFLATION is pure and simple THEFT of their wealth and start demanding higher pay hikes than the inflation rate which means go on strikes, which I am sure that the planned austerity cuts will act as a triggering mechanism for, to make all workers more militant. The effect of striking workers is INFLATIONARY ! Because even marginally less goods and services produced act to force up prices, a ratcheting up effect, the higher inflation goes the less control the government or Bank of England will have over inflation as it will become LESS responsive to interest rate hikes because people start to lose faith in the currency, they don't want to hold onto something that is fast losing its value, they want to get rid of it, SPEND it on goods and services if which they don't really want which is basically the path towards hyper-inflation.
The governments are always playing a dangerous game with inflation because governments NEED inflation to DEVALUE the DEBT, but populations REACT to persistently high inflation by increasingly becoming more reluctant to hold the currency, they want out, whether its into hard assets, consumer goods or alternative currencies, and another point to consider is that the spark for high inflation has already been lit by the budget busting black hole across the Atlantic that is burning the worlds reserve currency as though there is no tomorrow, in which respect there is no way that the British Pound will be able to escape its event horizon as both the dollar and sterling are heading for the same final destination.
In my opinion Britain needs to get a grip on inflation NOW by RAISING INTEREST RATES. If we delay until say a financial crisis hits emanating out of the United States then it will be too late to raise interest rates, increasing from 0.5% to 5% to prevent currencies from collapsing will probably have NO EFFECT, because it will be just too late, just as the Bank of England cutting interest rates from 5% in October 2008 to March 2009 had less effect than if it had taken place earlier. So raising interest rates amidst a global bond / currency market panic will be TOO LATE, as people will be reluctant to hold their wealth in either US or UK paper. All the signs are there in the commodity markets, gold breaking above $1275 is not a sign of deflation its a sign of ACCELERATING REAL INFLATION. January's Inflation Mega-trend Ebook (FREE DOWNLOAD) contained over 50 pages of inflation protection strategies that are still valid today, if you have not already done so then you seriously do need to consider steps today to protect your wealth BEFORE it is too late.
I also elaborated upon the bond market risks in the recent article (26 Aug 2010 - Deflation Delusion Continues as Economies Trend Towards High Inflation ) because when so many institutions and people have flooded into government bonds such as U.S. Treasuries, its not going to take much to spark a panic, because when traders seek to monetize on a trend say in commodity markets then the asset they will be selling to fund that trade will be government bonds! and so the bond markets are primed for a chain reaction event that bursts the global bond market bubble and sends currencies collapsing against one another and inflation soaring as investors flood into hard assets.
So despite the current atmosphere of an highly artificial interest market that is trending towards a crash (much higher market interest rates), I will try to conclude towards a UK interest rate trend forecast in an forthcoming in-depth analysis (next analysis in this sequence will be on the trend expectations for the British Pound), to receive this in your email in box ensure you are subscribed to my always free newsletter.
Conclusion
UK Inflation at above 3% for the whole of 2010 is not by accident it is by design, so forget the mantra of deflation or of temporarily high inflation of 3.1% and prepare your self for stealth debt defaulting inflation of 3% to 6% for many years (on the governments CPI preferred measure, even higher real inflation). Interest rates will rise but not so far as to prick the unsaid new inflation target range of 3% to 6% (unless there is an hyperinflationary panic). As for bond investors, they continue to sleep walk towards a mega crash as the inflation range of 3% to 6% will likely include bone crushing spikes as high as 9%! (with risk of far worse during an hyperinflationary crash).
Those in other countries such as the United States are on a similar path, which similarly implies much higher future inflation as a consequence of their own stealth debt default trend. In fact the longer the U.S. Fed delays in forcing up US inflation then the higher it will have to spike in the future as the larger will be the debt burden to deal with in terms of % of GDP. Therefore expectations for Deflation IS a construct of delusional freakanomics.
Why are bond investors so blind to the inevitable crash ?
Most are bankster's that are monetizing government debt and virtually all of the big players are leveraged which is why the bankster's are making huge profits by borrowing at 0.5% from the Bank of England then buying longer dated government bonds at 3.5% on leverage at say X20 (usually much higher) that converts into a profit of 3% X20 = 60%! this demand has the effect of depressing gilt yields down so bond prices rise thus another 20% profit is made for every 1% rise in the bond price. Off course during a bond market crash leverage works in reverse as a mere 10% drop converts into an instant 200% loss (at X20 leverage) and another bankrupt too big to fail bank for the tax payers to step in and bailout again.
This also suggests an anomaly is possible, of high inflation with low interest rates, because the bankster elite are enticed into perpetually financing government debt at low long-term interest rates in exchange for huge profits, as what do the bankster's care if the inflation rate is at 6% and the base interest rate is 0.5% because they can buy borrow at 0.5% and buy bonds at 3.5% for a profit of 60% against an inflation cost of just 6%, this thus prevents long-term bond market interest rates from rising as is normally the case i.e. long-term interest rates are usually positive (above inflation). Which effectively means that governments are able to ROLL OVER MATURING LONG-TERM DEBT AT INTEREST RATES BELOW THE RATE OF INFLATION!!! i.e. A mechanism for Maximising debt default through high inflation! Which is the ultimate purpose of Q.E. - The consensus (academic economists) view is that governments have to roll over maturing debt at HIGHER interest rates as a consequence of HIGHER inflation.
However the interest rate risks are transferred to the currency markets and this also suggests that the risk of hyperinflation is higher as the system is geared towards perpetually increasing debt until the bubble bursts amidst an hyperinflationary panic rather than mechanisms for less severe normalisation of debt due to just high inflation but rather an hyperinflation outcome.
This conclusion is getting rather long so I am going to have to spend some more time contemplating what this all means with regards to the forthcoming UK interest rate forecast conclusion.
Stocks Stealth Bull Market Trend Update
The Dow closed up on the week at 10,608, and continues to trend in line with my last quick analysis (29 Aug 2010 - UK Economy Booms Whilst U.S. Stutters, Stocks Fail to Follow Crash Script ) that concluded in an anticipated break of the downtrend channel that the Dow had been in, with the primary buy trigger at 10,200 to target the top of its trading range of 10,700.
The Dow remains in its corrective trading range that continues to work off the preceding 13 months bull run, 4 months so far, with my last in depth analysis (16th May 2010 - Stocks Bull Market Hits Eurozone Debt Crisis Brick Wall, Forecast Into July 2010 ) concluding that the corrective sideways trend could extend all the way into early October, so far the Dow is pretty much following the script, the more time the stock market spends within its corrective trading range the more powerful will be the eventual breakout, then those waiting for corrections to enter will be waiting all the way to Dow 12,000+!
My next in depth analysis remains pending as the Dow remains within its trading range of approx 10,700 to 10,000. However my original expectations for the year remain for the Dow to target 12,000 to 12,500 by year end as illustrated by the below graph from the Inflation Mega-Trend Ebook (FREE DOWNLOAD). The longer term trend remains as I voiced right at the very bottom in March 2009 (15 Mar 2009 - Stealth Bull Market Follows Stocks Bear Market Bottom at Dow 6,470), is for the stock market to have entered into a multi-year bull market, so far the market has done NOTHING to negate this scenario.
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By Nadeem Walayat
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Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem's forward looking analysis specialises on UK inflation, economy, interest rates and the housing market and he is the author of the NEW Inflation Mega-Trend ebook that can be downloaded for Free. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 500 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk
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