Friday, June 20, 2008
G-G-Gosh... Can They Do That?
The Bloke is writing another paper for the TPA, and is currently researching the notorious Barnett Formula, the one that allocates all those zillions of English taxpayers' money to the Scots.
It turns out that Barnett was simply a modification to a formula originally laid down in 1888 by George Goschen, Chancellor under Lord Salisbury. He invented the "Goschen proportions", under which a certain block of central government funding was allocated in fixed proportions between England, Scotland, and Ireland (Wales? Oh, they were simply subsumed in England). But more of that anon.
What also caught the Bloke's eye was that in that same 1888 Budget, Goschen pushed through a major restructuring of the National Debt. In brief, he converted the existing stock of government consolidated debt from a coupon of 3 percent down to 2.75 percent immediately, and to 2.5 percent from 1903.
OK, let's put that into English.
Goschen said to the widows, orphans, and everyone else whose precious life savings had been invested in rock solid gilt-edge government bonds, oh, he said, oh, I know we promised to pay you 3% pa for ever, but we've changed our minds. From here on in, we're only going to pay you 2.75%. And that's only for the next 15 years, after which we'll pay you 2.5% pa. I commend this statement to the House.
Can they do that? For a widow or orphan with no other income, a cut from a 3 percent coupon to 2.5 percent is a massive 17% cut in living standards. Just like that.
Of course, the answer is they can do that, and have done on more than one occasion. The most recent was in 1931, when the coupon on WW1 debt was cut from 5% to 3.5%. A shocking reminder that we should never trust politicos with our savings.
So could they get away with the same trick today?
Possibly not: much more of our savings are today channelled through collective investment funds of one kind or another, and their managers are much less likely to lie back and think of England.
But then again, in 1931 we were only just coming off the Gold Standard, and our politicos hadn't yet rediscovered the joys of the inflation tax. Once you start printing money willy-nilly, you don't need to cut coupons - you simply inflate your way out of debt.
Which brings us back to the Bank of England's anti-inflation mandate (see this blog). The public sector currently has around £500bn of debt fixed in nominal (ie money) terms. At 2% pa inflation, the real debt is being eroded by around £10bn pa (aka the inflation tax). At 4% pa inflation, it erodes by £20bn pa, a windfall for the government of £10bn pa.
It's a no-brainer.
A scary no-brainer.
PS George Goschen (pic above) vs A Darling for the post of Chancellor. Goschen got a first at Oxford, worked in the City, became a Bank of England Director at 25, wrote a standard work on the foreign exchange markets, and was President of the Royal Statistical Society while still Chancellor. Darling did none of the above.