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Advanced EconomicsWhile researching an unrelated topic, we came across a strange piece of economic work whose bibliographic link can be found at the end of this article. It is supposed to be a study about governments and their spending and saving habits. For that, they complied and developed a very interesting database which will probably serve us well in future articles. Today however, we are only going to take a look at the twisted optic under which government economists, apparatchiks and politicians look at so-called "state finances". This will provide a few answers as to why their view of the world is utterly ludicrous and completely and hopelessly out-of-synch with reality. Additionally and as a bonus we will show how data is manipulated in order to show whatever it is meant to show. To task.

BACKGROUND

The below referred research paper is intended to provide information to help people and politicians to determine "whether a country’s fiscal policies are appropriate to support economic growth and achieve other social objectives without causing a fiscal crisis". In and by itself this statement seems quite reasonable, but is it? The authors of the paper seem honest enough since they only apply existing methodologies to do their work which is, in their own words, "state of the art" (the paper was published in 2013). That is not the problem. The problem are the highly questionable parameters and calculations used by the economic profession as a whole to measure financial sustainability of governments.

It is to be noted that the paper itself was published by the International Monetary Fund, a bastion of classic economic thinking if there is one. This is pure mainstream economic thinking at work.

DEBT AND PRIMARY BALANCE

The article begins with a summary and explanation of the graph below, which we are going to clarify

World Debt - Prudency and Profilgacy

Debt

In Fig 1 (above) we see three coloured lines and a gray band. Each one of them represents a level of government debt expressed as a percentage of GDP over 160 years of "modern democracy". We will ignore the green line since reality-wise is the least important. Take a look at the blue and red ones. They represent a measure of typical world-government debt in history. The red line is closer to typical total debt while the blue line is close a typical middle-of-the-road country debt. In general, they are both quite close and so we will treat them as one and the same.

The first thing we notice is that over the last 160 year the debt of all countries on earth oscillated around the 50% GDP mark, which is nothing short of astounding. If we now consider that the GDP is a deeply flawed measure (see GDP Keynessians Vodoo Economics) containing among other things printed money (i.e non-wealth also known as an accounting trick), it is clear that the real debt is much, much higher. How much higher it is difficult to gauge because the researchers did not bother to correct the GDP either by inflation or printing.

Consider the following facts.

To compare something against the GDP is pure nonsense and an incredible arrogance. Let's assume for a second that the GDP really represents the true value of goods and services produced by a country in a year. Why is government debt compared against this number? The government does not own the wealth in the GDP. It is not theirs to dispose of. By comparing debt against GDP the underlying automated assumption is that the government can dispose of the entire GDP at will.

Let's scale this situation down a little bit to see how ridiculous it is. Let's say that you have a 10,000 SFr debt in your credit card. Your annual salary is 50,000 SFr. A quick calculation will show that your ratio of debt to salary is 1 to 5 or 20%. In government terms, this would be the ratio of debt to revenue. But you don't like those numbers. You want to have a "lower" ratio. What do you do? Simple. You add all the salaries of all the people living in your building (let's say totalling 500,000 SFr) and then you recalculate your debt ratio. Presto! Your debt ratio is now 2% of GBP (Gross Building Product). Does this make any sense? No. Does this calculation decrease the amount of your debt? No. Can you even do this calculation? No because their salaries are not yours. Yet, for some strange reason, governments fell that all your wealth is theirs. This is what comparing anything governmental to GDP means.

Now let's go a step further. Let's say that your counter argument is that the second calculation is valid because you have a protection racket going on in the building and you routinely "shake" all the inhabitants for money. Whoever does not pay suffer the consequences… you know… this person is made an offer they can't refuse. Therefore this calculation is valid because the higher the salary of the building inhabitants, the more money you can extort! If this seems a completely unacceptable argument for private people, why do you accept it for governments? They all have "protection rackets" going on and they all "shake" (tax) you and they all have "enforcers" (those people with badges and guns) who routinely make offers nobody can refuse.

Yet this is precisely their point of view. Their protection racket is "legal" and what is yours is in reality theirs. To make matters even more outrageous they cloak their data in this kind of statistical nonsense. Depressed yet?

All this kind of statistical nonsense is specifically designed not to make any sense but to look good and impressive. Take for example the EU so-called "Stability and Growth Pact" which established the maximum amount of debt as 60% of GDP. However, this level was considered "insufficiently flexible" and in 2005 it was modified to a calculation including "future revenue and growth". Right! If it would have been up to us, we would have insisted in adding a variable representing Moon phases. At least in this manner there would be something predictable in it. So, it is not only insufficient to have meaningless and arrogant measures, on top of that we must even make them larger because there is insufficient cheating (for info on this pact, search Wikipedia for "Stability and Growth Pact").

Primary Balance

In Fig 2 above we can see a second parameter. This is naively called "Primary Balance" which suggests that it is something along the lines of being basic or unprocessed or gross debt. Nothing could be further from the truth. The OECD defines Primary Balance as "government net borrowing or net lending excluding interest payments on consolidated government liabilities". In other words, Primary Balance is the difference between what a government spent and what a government received, excluding debt and its interest payments. Its like looking at your finances ignoring your debt! Does this make any sens? At all? Of course not. But according to the IMF, this indicator is supposed to be a better gauge of "fiscal effort" (whatever this may mean) than the overall balance which is a balance as you or us or any accountant would normally understand it (all revenues minus all expenditures).

And so the Primary Balance (i.e. a fake balance) is "better" to show the "real" financial state in which governments find themselves. We have to wonder, "better" for whom? In any case, Fig 2 shows that in general terms (excepting WWI and WWII) the Primary Balance expressed as a percentage of GDP is around zero! Fantastic! Impressive! There you have it. Proof positive that those tireless workers, our representatives, are indeed good stewards of your money. Alles ist gut mein Kind, schlaf gut.

Or are you with us looking at the sleight of hand and screaming: misdirection! misdirection! Mommy! Mommy! I know how they did this trick!

Look, this is not complicated; they only make it look complicated. They take a fake balance which conveniently omits key liabilities and compare it with a nonsensical and arrogant measure! Gee… what did you expect to see? Gloom and doom? Not a chance. Gloom and doom don't get politicians elected.

Retaking from our previous example, let's say that your 10,000 SFr have a yearly interest of 8%. This would mean that every year you must pay 800 SFr in interest. But you conveniently "forget" to subtract this from your salary because…it makes you look bad! Those 800 SFr are still there and you still owe them and you will still need to pay them. Meanwhile, however, you look good!

Note: please see the Glossary if you are unfamiliar with certain words.

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