Recession! Questions answered!

Posted on October 3, 2011
Location: London
Recession! Questions answered!

We’re all money aware but even the most clued-up among us have questions about the world’s increasingly empty wallet. I had these questions myself for very long time, I am sure many of us still do. I am sure composition will be informative.

£ The world has £25.5 trillion public debt, with two countries combined (the USA and Japan) owing half that total. Who, exactly, do they need to pay back?

They need to pay whoever bought the bonds (also called gilts) that these governments sold to raise money when they needed more cash than they received in tax revenues. These bonds, basically chunks of debt, are bought by large financial institutions, who earn interest on these investments. Because 70% of UK government debt is owned by British investors, we both owe money, and are also owed it. It differs from country to country though – in the Eurozone, French banks own German debt and vice versa because it’s a single currency. Most US debt is owed to American citizens, although a large and growing proportion is owed to the Chinese government.

£ So if huge debt is crippling countries globally, why don’t we just write it all off and start again?

It would lead to the collapse of the whole financial system. There is actually nothing wrong with debt; few, if any, countries have none at all. Clearing debt globally wouldn’t be the same as the cancellation of third world debt, when rich countries wrote off the loans poor countries couldn’t pay back in the Eighties. That was nowhere near the amount of money we’re talking now, and it was cleared over a long period of time, allowing for economic adjustment. We can write some small scale debt off – like with Greece, which is a small country with debt that is too big, relative to the country’s size and output, to ever pay back. Governments wouldn’t be doing any favours by writing all debt off either. Currently the UK owes £940.1 billion in public debt, which equates to over £15,000 per person. It’s money we essentially owe ourselves, as it was borrowed from domestic banks and pension funds. If this were to be cancelled, your taxes would go down but your pensions and savings would disappear too. You’d be effectively paying off your debt with your own pension.

£ If we need more money, can’t we just print more £50 notes?

We are – sort of. The Bank of England has been creating cash electronically, by buying back some of the bonds they issued (though they’re not actually printing banknotes to do so). It’s called ‘quantitative easing’, and is an extreme measure to pump cash back into the economy. It puts more money into institutions’ accounts (including commercial banks or other financial businesses such as insurance companies), which is a roundabout way of pumping it back into the wider economy.

£ What would happen if we switched to the Euro now and could it still happen?

It isn’t even being considered – in fact, chancellor George Osborne recently said we should ‘thank God’ we never did. An advantage of joining a single currency is that it reduces transaction costs (basically, the cost of changing money) and hence makes trade and travel easier, which is great in a booming economy. But it removes an important safety valve in a downturn. If economic conditions worsen here, then the pound will fall, making our exports cheaper and imports more expensive. This will reduce our standard of living but increase economic growth, allowing the economy to adjust more easily. If you’re in a single currency, this can’t happen, which is a difficulty faced by Greece at the moment.

£ What does the Greek crisis have to do with us if we are not in the Eurozone, or America’s debt if we don’t use the dollar?

Firstly, most of our trade is with Eurozone countries, so if they suffer we do too, because they aren’t buying our goods and services. Second, there is the interlinked nature of banks. People are worried that if Greece defaults on its debt, so might Ireland and Portugal. The whole system relies on banks having confidence in each other and when that disappears, panic spreads and can lead to the entire system toppling in a domino effect.

£ When we send aid to a natural disaster where does that money come from? Shouldn’t we stop sending cash to Somalian refugees and focus on our own country’s economic woes?

The money comes from our taxes, so when the government helps famine victims, that money could have been used for schools and hospitals here. Polls show that seven out of 10 voters want Britain’s spending on foreign aid frozen or slashed but the government has chosen not to ‘balance the budget on the back of the world’s poor.

£ Why is the government cutting spending to grow our economy?

Long term, the government spend on services and goods everything from pencils and carriers to civil servants’ salaries, line with what it receives in tax revenues, so the current deficit need to be reduced. They believe, in order to preserve investors’ confidence and keep money in, cuts should be large and quick.

£ What would happen if we stopped spending and just saved?

It would be a disaster. Banks lend your savings to businesses, so for them every debt is an asset. If no-one borrows, no-one can save, so investment would dry up and output and employment would collapse. While people did borrow more than they could afford and some banks made bad lending decisions, the role of the financial system is to channel money from savers to borrowers, and both are necessary to a functioning modern economy.

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