Budgets — one of my most requested finance training topics. For the UK the next national budget will be presented by Chancellor of the Exchequer Rishi Sunak on March 3rd. We don’t yet know exactly what will be in it, but a look back to last year provide an interesting frame of reference.
· On 11th March 2020, Sunak presented his budget which included some £12 billion of coronavirus support.
· On 20th March he announced an additional package of financial support, arguably around £300 billion.
Where did the extra £288 billion come from, within a period of 10 days?
This led my daughter to ask the key question “Dad, who will pay for all this?”.
Which in turn lead to my even more key answer: “You.”
(In practice not just my daughter, but a whole generation, maybe that generation’s children too.)
How is this fine — when you will find the same approach most definitely will not work if you try it with your personal financial situation?
The answer — Modern Monetary Theory (MMT).
There is a fab article which discuses this on Public Finance Focus this week — see below. (Needs 5/6 minutes of good concentration if you are up for that.)
MMT is being connected to the ‘magic money tree’ — the concept of seemingly limitless government spending, financed by debt which does not have to repaid and which has a record low interest rate. Often referred to in the UK is the process of Quantitative Easing (QE). What could possibly go wrong?
If Rishi Sunak seems not that bothered, why should we be? Let me present some seemingly random thoughts:
· Small inside page report on 13th January in the Financial Times revealing the Bank of England does not really understand QE. I love the phrase that Bank of England Governor Andrew Bailey ‘agrees with Federal Reserve chairman Ben Bernanke that QE “works in practice but not in theory,”’
· Another part of this economic toolbox is the concept of negative interest rates — already tried in Scandinavia and Japan.
· HSBC have today sent me revised T&Cs for my business banking — including the revelation that negative interest rates will not be applied to me: if they go negative the Bank of England Base Rate will be regarded as zero.
· The UK’s Financial Conduct Authority Financial Lives Survey reports in February 2020, 39% of adults (20.3m) said they could only continue to cover their living expenses for less than three months, if they lost their main source of household income. By the way, in May 2021 the repayments commence of Bounce Back Loans….
· The Bank of England’s Chief Economist suggest the UK economy is like a ‘coiled spring’ and that we can expect a steep recovery once lockdown ends. Has he read the FCA Survey?
· MMT is the most recent economic theory to drive our decision making. I am old enough to have experienced Monetarism from Milton Friedman and studied Maynard (not Milton!) Keynes. The only school textbook I have kept.
As long as the theory (even if it only works in practice) of MMT is ‘in vogue’, we can expect continued government expenditure — sorry, support. This means the budget on March 3rd will probably keep spending, and not raise taxes.
This affects other countries besides the UK — look at what ‘Uncle Joe’ may be planning for the US — another round of cheques? The EU has its own support mechanism planned too.
But note the underlying supposition to MMT: all government expenditure is eventually recovered in taxes. Enjoy March 3rd — or your own governments budget day — while it lasts. It will probably be reckoned with eventually. Even if it my daughter’s generation that will do the reckoning.
Buzzwords of the Week — Gearing (or Leverage)
Definition — The relationship, or ratio, of a company’s debt-to-equity (D/E). Gearing shows the extent that a firm’s operations are funded by lenders versus shareholders — also called financial leverage. The higher the proportion of debt-to-equity, then a business may be considered highly geared, or highly leveraged.
Alternate View — Maybe a useful warning indicator, when viewed alongside low levels of Interest Cover, or cash flow problems meaning a company cannot make debt repayments when due. High gearing = higher financial risk. Much debate about whether low gearing is better than high gearing — in short, it depends on your cash flow. Some of the gearing debate displaced by measuring debt not to equity but to EBITDA, arguably a measure of repayment ability. Or maybe it just makes the numbers look better.