EU Debt Crisis Summit June 2012 – Why It Is Better For Governments To Do Nothing

Government debt keeps getting larger even when adjusted for inflation. That’s it. For that reason alone governments trying to “help” economies can only make the EU debt crisis worse.

That fact alone shows that the EU’s attempts to implements a pan-European government spending plan will destroy wealth and hinder job creation.

I think writing an article explaining this phenomenon is going to labour the point but just in case it’s not clear how this works, let me explain.

Let me start by explaining the fundamentals of borrowing money, why it happens and what it achieves.

When a business borrows money it does so because not only does it think it can pay back the principle but it also believes it can pay the interest on the loan and not only that, the business also believes that it will be financially better off by borrowing.

More labouring of the point here, so in summary, the business is better off financially by taking the loan than by not taking it.

EU governments on the other hand…

All governments in the EU and any western government for that matter, consistently borrows hundreds of billions of Euros every year and they are unable to pay back the principle, and not only that, the only way European governments  can service their debt is by taking out more debt.

If a business was borrowing as much as EU governments, as a shareholder in that business, you would be expecting some sort of return on your investment in the future in the form of dividends at the very least. Governments on the other hand are not able to pay dividends. In short, government borrowing provides absolutely no benefits.

Okay, you have people and banks that invest in government debt but it is not the government that pays the yield on government debt, it is taxpayers.

The EU debt crisis plans and the Eurobond – All evidence shows government spending destroys jobs and reduces prosperity

In other words, the only reason governments can borrow is because taxpayers are on the hook for the debt and not because the government produces any value with the money it borrows.

The government gets a pass because the efficiency of business increases and not because governments efficiency increases.

Unless of course you class increasing taxation and reduced services to service the debt as a return on investment.

And that opens up a completely new can of worms. If you are an investor in government debt, is the fact that you get a yield on your investment because the population of a country has to receive fewer services and pay higher taxes something that should be encouraged? Is this is a desirable situation?

Okay, for the investor in government debt you could say yes. But as a government, is it a desirable and indeed moral thing to be doing this to your electorate ie hindering them with higher taxes and reduced services?

But I am straying from the point.

I am writing this article to quash the myth that the EU governments are able in anyway to help the EU ecnonomy and to quash the myth that Eurobonds will help Europe in anyway. Eurobonds will not create wealth or jobs, and it is impossible for EU governments to create jobs the evidence is everywhere.

So how does a business measure an increase in prosperity?

Well the most relevant KPI when comparing to the US government would be increasing profits, whether that be through greater sales or more profit per sale.

To give an example. A business borrows 100 Euros because it believes the investment will lead to a 20% increase in profits, for example it invests in a new piece of equipment that make production more efficient.

If the business borrows 100 dollars over 10 years, it pays back the principle plus 10% interest and is left with 80 dollars profit (simplified I know but I hope you get the idea).

So how does a European government compare if it were to borrow 100 euros?

For a start the European government would never be able to pay back the principle. That immediately shows the money was wasted and would have been better left in the pocket of taxpayers.

With regards to the interest, yes, the European country’s government could service the debt and that is it. Even if we assume the government of this EU country does not have to take out more debt to cover the interest payments it is still a complete waste of money because the principle cannot be repaid. This alone shows the money was wasted.

Okay you may say, how would you know if government spending actually created jobs and economic growth?

Well for a start you would expect higher tax revenues with the same level of taxation. I have yet to see this happen consistently anywhere. Sure you have booms where tax revenues increase but then we have busts which wipe out the gains. (Maybe not completely so let me expand that point).

In the booms the government inevitably increase their debt by borrowing more because money is cheaper. So although the economy may not contract in a bust to its pre boom levels the debt of the country will have increased, wiping out the gains as mentioned above.

There is no way a business could borrow money when this is the inevitable outcome or if this was its track record. And there is no way a private citizen could borrow money if this was the inevitable outcome.

Well that is not strictly correct, there is a circumstance when banks would lend to a business or individual under these circumstances and that is when the interest rate is high like a credit card.

The bank is quite happy to let you run up a huge credit card bill as long as you are able to pay the extortionate interest rates. And where does this leave the borrower, with a big credit card bill. Would you class that as increased prosperity?

Sure there are ways this can work out, for example the investment has a bigger return than the high interest payment buts lets not kid ourselves here, the government is not even going to pay back the principle so lets not have any illusions that a high interest rate is a good thing. The government is in no way as profitable as a casino, at least not for the taxpayer.

So in short, the credit card argument is not relevant to government at least if you try to justify it by the government doing something which pays back the interest, the principle and helps the economy in the long run, that is simply not going to happen.

So in short government spending never helps the economy. The very best case scenario is that taxpayers end up paying higher taxes to service the higher debt. Or taxpayers end paying the same taxes with reduced services. Or in the case of Greece, taxpayers end up paying higher taxes and get reduced services.

And that’s it. I hope this article shows how EU governments cannot in now way help the EU economy and how any “solution” which emerge from this EU Summit will only make matters worse (unless they propose massive taxcuts and government spending cuts).

Government spending can never ever lead to economic prosperity.

There simply is no evidence so support it. And more than that, all evidence shows the exact opposite ie the more government spends the worse off citizens are.

The next time Barroso/Draghi/Hollande talks about solutions to the European debt crisis here are the questions that need to be asked.

When will the principle including the interest be paid back on the borrowing they propose is the answer.

and

what will be the net result to the EU taxpayer, ie how much will tax revenues increase using today’s tax levels.

Assuming the EU and the ECB have an answer to these 2 questions you will need an answer to this follow-up question.

Assuming 50% of government spending helps the EU economy (I am sure Barroso/van Rumpuy will say 100% of government spending helps the EU economy but lets give him a chance and say only 50% does) how much do they expect the public debt to come down by in the next ten years giving the hundred of billions of Euros the EU government is borrowing to “benefit” the Europeans people.

And this one we all know the answer to, the debt of EU governments is only going one way, up.

So in short, even if EU leaders can lay out some figures showing how their Euro rescue plan is a good idea, the reality is nothing the governments are doing is helping the EU economy so why should anyone believe this EU debt crisis summit  will be any different, especially as the government will try to say that the current situation of massive government borrowing is good for EU taxpayers.

If the EU governments are not able to pay pack the principle and the interest on their borrowings within 10 years then the money is better off being left in the private sector and used by businesses who can make much better use of the money.

I hope I didn’t labour the point too much and as always, your comments are welcome, for and against!

Get the latest updates in your inbox