Spending our way into trouble

Over the weekend, Alistair Darling will be putting the finishing touches to his pre-budget report. Judging by the pre-statement leaks, Darling is going to cut taxes, increase spending and make up the difference with a large does of financial irresponsibility.

We all know, deep down, that it won't work. Afterall, does anyone remember the Bush stimulus package from this year? In the second quarter, the Federal government mailed out cheques amounting to $160 billion; three months later, the economy shrank and unemployment hit a 16 year high.

Pointing to transatlantic failures never deterred a British politician from doing something stupid. Critics of the upcoming spendathon need to develop a more coherent critique. In particular, we need to hammer home one basic point; every fiscal stimulus needs to be paid for. There are only two ways a government can do that; print money or borrow.

If the government doesn't have the money, the Bank of England can print it for them

Governments don't always have to raise taxes. It can get the central bank to make money. All it needs is a printing press, a few tonnes of paper, and a comforting picture of her majesty.

Rather going straight into the inflationary conquences of such a patently erroneous idea, lets take a more european route and start by asking a seemingly daft question? Hands up anyone you thinks the UK is in the European Monetary Union. What, no hands? Wake up, people; the UK is in EMU, it simply hasn't adopted the euro.

What has this got to do with the BoE helping out by printing up a few quick fifties and handing them over the the capable hands of Brown and Darling? Well, membership of the EMU prohibits central bank credit to the government. That means that the Bank of England can not legally crank up the printing presses. Brussels won't allow it.

The reason for this should be obvious. The ECB, being a supranational central bank can not give credit to individual member state governments. If the ECB can't do it, then why should the BoE be allowed.

In any event, everyone knows that printing lots of money creates lots of inflation. Just ask any Zimbabwean, who always seem to have an impressive understanding of monetary economics. This is why the EMU prohibition on credit to the government is such a wonderful thing. It almost makes EU membership worthwhile.

Borrow now, pay later

The greatest lie ever invented in modern economics was the one that said that the government budget does not work like a family budget. The idea is that governments can borrow from "within the family" and use the money to boost expenditure when times are rough. On the contrary, government finances are exactly like those of a family. If the father borrows, the children pay.

Take Italy as a grim example; in the 1970s, successive governments bought off an aggressive union movement and stroppy public sector workers with huge government deficits. The public sector debt stock exploded, reaching over 100 percent of GDP. A sorry procession of Italian governments tried to push the problem into the future with more borrowing. However, creditors had little patience with Italian debt, as soon as they saw more of it emerging from the Italian Treasury, they demanded higher interest rates.

Those high spending 1970s left Italy in a semi-permanent fiscal crisis. The debt stock remains high, the government pays out several percentage points in interest payments, leaving the whole sorry mess to the next generation of taxpayers.

Prudence, where did you go?

I do wish she would would return; I always liked her.

Governments should set the tone for the rest of the economy. Sound financial management; low tax levels, zero debt levels, and no deficits - that is the magic recipe. If the government behaves itself, then the private sector will follow.

Likewise, the Bank of England should keep monetary growth under control; and never extend credit to jokers like Brown. For its part, the Financial Services Agency should keep the banks on a tight leash, because they will misbehave if you let them.

Above all, get the basics right; and leave the private sector alone to look after itself.