General election: financial plans that just don't add up!Posted on: 28 April 2010 by Mark O'haire
As Gordon Brown, David Cameron and Nick Clegg prepare for the final prime ministerial debate, financial expert, Peter McGahan, analyses the spending plans of the three major parties.
The UK election - what a bundle of joy! I do laugh at the drive to save money, tax us for driving the ‘wrong’ cars and inappropriate use of energy, yet millions are spent on the spin and twaddle to encourage us to vote.
It’s a futile position in any event as no matter who you vote for, a politician always gets in.
I have often thought they should be made to supply us with a simple email explaining in bullet points what they will definitely do and what they might do. That would be sufficient to help us make our decisions. But somehow massive advertisement campaigns and millions of expense seems to be a preferred option.
In a bid to woo us, each of the three parties have presented their manifesto, while the consensus on the election outcome points head first to a hung parliament.
So do any of the manifestos make sense or are they all vote winners that will be dumped when the true extent of the state of our economy is highlighted?
In this column in 2008, I called the beginning of the recession just as the market was hitting its peak and everyone thought runaway inflation would be the problem rather than an Armageddon-style recession.
I also pointed out why the government would try and pull forward the inevitable recession so it could design the 'recession exit' to fit perfectly with the election and be seen as the people who lead us out of that recession.
As cynical as that was, everything has been ticked off according to that great plan.
Much of the manifesto content (all of them) is based on amazing assumptions, so I could begin by stating that none of them will probably work and save you the bother of reading any further!
In this review I will cover each manifesto separately and I will then summarise what threats each government has when they come into power that they haven't yet considered in their manifestos, and without which, much of their thoughts are just dreams - or nightmares.
I might add that I am totally independent. In my 42-years on this earth I have never actually been able to put my X next to anyone and so have never voted - I simply want the best for the voter.
So let's look at each financial aspect of each manifesto in a bit more detail.
- No explanation on impact of spending cuts
- Banking crisis
- Will this study prove true in today's market?
- What can we learn from others?
- Global deleveraging
- So what is deleveraging?
- Hung Parliament impacting the markets
- Which parties have been best for the stock market?
How the parties score
Unfortunately as I've said before, all three parties have been keen to talk about making massive cuts in spending and cut public spending while reducing wages. They haven't however, explained how that will impact spending and growth in Gross Domestic Product (GDP) and I am not sure they understand that themselves.
I think it's beyond them and expect all the numbers to change so stay tuned for that.
Instead of cuts, if they were talking about introducing that sort of level of input into the system, they would be explaining exactly how it would add value to GDP, yet there is no detail regarding the reverse.
It seems that neither parties have considered the very obvious facts in relation to the global financial crisis we have had and how that will impact GDP going forward. To ignore the expected outputs (which is what all parties have done), will leave a gaping hole in the financial planning of the country.
Here are some points I made in February 2009 regarding the banking crisis -
A recession is one thing, but financial crises, particular in the form of banking crises are another.
In 2007, a study by Reinhart and Rogoff accurately compared the run up to the US subprime crisis with the antecedents of other banking crises.
They continued in 2008 to analyse the antecedents and aftermath of banking crises in both rich and emerging countries. There have been 18 post-war banking crises and the study included them all.
What was most surprising was how alike they were. One would have expected them to be very different. It's worth studying financial crises to see how they specifically affect economies as a whole.
Financial crises are not overnight events and they share commonalities, whether in developed or emerging economies:
- Asset prices collapse, with fixed assets such as real estate/property falling 35% on average and the downturn lasting six years;
- Equities bomb 55% and the cycles last 3.4 years;
- Unemployment rises on average by 7% and the rise in unemployment last five years. This will be a huge drain on the purse in terms of lost revenue and also extra expenditure in terms of benefits.
- One of the reasons emerging markets were less impacted was their flexibility to reduce wages and if the Uk is to follow suit (it looks like they are) the impact on spending and in turn GDP will be colossal;
- Output falls by around 9% and this typically takes two years;
Not to be outdone, the real value of government debt explodes by 86% with the cost of replacing lost taxes being the key factor, rather than the much whinged about ‘bailing out of banks’ which in practise has very little impact but its an easy target to swing a hatchet at.
Moving through to the economy it's interesting that the cycle from peak to trough in GDP is only two years, and perhaps Mr Brown’s cash injections will prove timely with the election - and they have.
Remember a normal recession lasts around a year. Indeed the study showed that multi-year recessions only really occur in countries that require a deep restructuring such as Britain in the 1970’s and Switzerland in the 1990’s.
Well, we could all say that the governments of today aren't as daft as the past, but I will leave that for the goldfish to consider. Most definitely the UK and US governments have shown considerable monetary flexibility, which wasn’t shown in the past, so that might be a differentiator, but it's difficult to see why this varies from the normal financial programmes of the past.
What is very different this time, is that most of these analyses were individual regional crises. This one is global and is a bigger bus to get moving by pushing, than the smaller smart car of yesteryear.
None of this is reflected in the wonderful optimism of either of the manifestos. Much of this will have impacted the price of sterling and that is undoubtedly a strategy of the British government to weaken it to support exports and in-turn also make the country a much cheaper place to holiday and a much more expensive place to leave for a holiday.
I'm not the only one who believes the government are expecting too much from that fall in the pound.
We know that Ireland have had the steepest recession of any developed country since the war and have responded with large cuts in budget. We also know that UK treasury officials have been in Ireland to study the impact the recession has had and the impact of the changes.
The Conservatives have said they will have a budget immediately if they get in. That will be painful. Ireland has had five in two years. Its actions however, have been welcomed in the credit markets as good planning.
In Ireland, the public spending cuts have not been welcome to the man on the street. Unemployment sits at 13.3% (UK is 7.8%) but I'll remind you about post-banking crisis and the fact that Ireland is ahead in its cycle.
The current manifestos from any of the parties don't appear to be strong enough in terms of tax rises and cuts in spending. It may be that Labour and the Tory's lack of detail relates to what they really know they will have to do, if they are looking at Ireland's example.
The changes Ireland made for example, took as much out of the economy in one year as the UK chancellor said would be taken out of the UK economy by 2015-2016. Whilst the Lib Dems have said we will be ready in 2011 to take some of this same medicine, the sort of medicine they are referring to would appear to be a little benign.
Ireland cut public sector salaries by 20% in many situations. They hit public sector earnings by a new pension levy of c7% to fund their expensive pensions. Public salaries were cut by 5% if you were earning less than €50k and 10% if you were earning more than that.
These sort of cuts were drastic but well received by the credit markets. However they have had a massive impact on the budget plans for Ireland which may well have been overlooked by the Lib Dems, or purposely not stated by the other two.
Ireland has had a deflationary impact with prices falling 4% economy-wide last year. We don't want that here. Deflation will explode our debts like an annoying volcano.
There's no doubt we will have to apply measures somewhere between what the Lib Dems have said (and the other two have not) and what Ireland has done, but if the UK should learn anything, it's to engage with the public regarding the extent of the problem and involve them in providing solutions.
It's one thing having pain forced on you, it's quite another to have felt you have taken a responsible attitude in its design.
Many of the parties manifestos don't appear to have considered the impact of deleveraging.
The McKinsey global institute has analysed 45 episodes since 1930 in which economies deleveraged. The UK had the largest increase in debt to GDP of the ten mature economies the report sampled, with its ratio reaching 469% and Spain and France following suit and the much maligned U.S. debt to GDP growing much more moderately.
The process of debt deleveraging is a long one which needs careful management. If history has any relevance, this will have a protracted impact on GDP which hits taxes and in turn government budgets. Debt deleveraging is particularly long after a financial crisis.
One might expect that the deleveraging process will last between six and seven years, so you can imagine the impact on finances.
There are four archetypes:
- Belt tightening
- Massive defaults
- High inflation
- Growing out of debt via an oil boom or other factor causing rapid growth such as a post war boom
Belt tightening is the most common (more than half). If ours follows suit we can expect to see GDP fall for three years before it grows.
I am already seeing this at an individual level with borrowers using the low rates to simply get rid of debt where they can. Banks have also deleveraged significantly.
If you are deleveraging you are not spending and GDP gets hammered.
Perhaps the biggest issue facing the incoming government will be how to cut out its debt without dropping us into a 1930s style U.S. or Japan.
Interestingly this is an easy question to answer. Many commentators have told me for years that markets don't like uncertainty. What's the true evidence?
Few are betting against a hung parliament and it really looks a foregone conclusion. Have a look at the stock market though - virtually uninterrupted, even with a mystic volcano.
I am sure the market makers will use the time closer to the election to create a bit of volatility for their own benefit, but the fact remains there's little impact. Much will depend on what truly happens if we do go to a hung parliament and on the behaviour of the politicians, so beware.
The best and worst returns were achieved by the Conservatives with Winston Churchill's third term producing 19.66% and Neville Chamberlain returning - 11.47%. Bond investors had their best and worst returns under a Labour government.
Overall however there is nothing to separate the two and in fact no real correlation between the party in power and market returns - perhaps a story in itself.
Prudence was a message extolled by Gordon Brown when he was Chancellor of the Exchequer, but does his 'sweetened' election budget promise security and future prosperity? How do Labour spending plans add up? Read how Labour plans score.
Vince Cable has stood out as a voice of reason throughout the financial crisis but how do his figures stack up and how will the Liberal Democrats balance the books if elected? Read how Lib Dems plans score.
The Conservatives' scaremongering over National Insurance rises are yet to be validated by any concrete proof that Tory plans can deliver a realistic alternative. Read how Conservatives plans score.
Need Expert Advice?
Peter McGahan is an Independent Financial Adviser and Managing Director of Worldwide Financial Planning. Worldwide has won 16 Financial Times awards in the last four years. Peter has also been named the top media IFA of the year by Unbiased.co.uk in 2009.
Peter comments regularly in major journals such as the Mail on Sunday, Irish News and Sunday Times and is a weekly columnist for FT Adviser. He has also appeared on Working Lunch and the Today programme. In addition he is an expert on international tax matters for a range of international publications.
Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made. The above represents the personal opinions of Peter McGahan. All information is based on understanding of current tax practices, which are subject to change. The value of shares and investments can go down as well as up.
If you have a financial query you would like Worldwide Financial Planning to respond to, call 0845 230 9876 or email firstname.lastname@example.org.
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