Public sector jobs declining, Government bonds up, what does this mean for us the public?

Firstly, let's just establish a couple of definitions. And please don't be embarrassed that perhaps you didn't understand what these mean or how the work, you are among many that don't, or many that pretend they know, but haven't got a clue and bluff their knowledge to try and prove they are aware of what's going on.

Public Sector Employment.

Anyone that relies on the state to pay their wages. However it also has to be remembered that many private sector employment relies heavily on the public sector. For instance, if a company supplies a local council with goods or services, then they too will be affected by cuts.

Should there be cuts? Well this is the big question, after all, if the jobs weren't needed in the first place, then why were they created? Governments sometimes increase the size of the public sector to hide poor employment. There is no evidence of this in the UK or US, it's merely an observation generally. It's easy for a Government to instruct local councils etc. to employ and create new tiers of employment because it does two (of many) important things. Firstly, it keeps the unemployment figure down, secondly, the public feel more confident in Government if they see more police, firefighters, better libraries etc.

Finally, please remember the basic, common sense figures for public sector wages. If, for example and for the sake of simplicity, you work in the private sector, earn £10,000 per annum, and pay £2,500 in taxation from that wage, then there needs to be at least three more like you to cover one public sector wage earner also earning £10,000. All public sector wages come from taxation. This is very simplistic, but the principle is sound. Governments also take money from other taxation such as VAT, Capital Gains, Inheritance etc. but this shows that you need a lot of private secor wage earners to cover the public sector. Therefore, with 8 million public sector wage earners, we need at least 36 million private sector workers to cover their wage bill in taxation.

But there aren't so where does all this come from?


Government debt, gilts and treasury bonds.

So how does government make up the shortfall in this public sector expense? And, public sector wages make up a relatively small amount of Government spending, what about roads, libraries, new ambulances... the list is endless.

Some money will come from the private sector investment. A private company may invest in an airport for instance, and get a return on their investment at a later date through exploitation of the site. This helps the Government by them not having to find public money from taxation, and also the company assumes (in most cases) responsibility for running the site.

Other money will come from Government Treasury Bonds (or gilts as they are sometimes called). A government will issue a Bond and promise to pay the bearer of the Bond their original investment plus interest.

So, as an example and with simplistic figures, a Government issues a bond for £100 with a 5 year term and promises a 5% return. That means that at the end of the term, the investor can cash in the bond and receive £105, a profit of £5. The Government takes the original £100 and invests it in the country (better trains for instance), this hopefully improves the economy, and allows the payment of £105 at the end of the 5 year term.

The Government is basically saying that although they haven't got the £100 today to pay for the new trains, they believe that they can increase the countries profits within the 5 years to pay that bit extra to the investor.

Bonds are a loan like any other. Government borrows and pays back the original sum with interest at a later date.

So governments use this money to make up for the shortfall in money they need to run the country, and the money they take in taxation.

Why don't they just take more in taxation, rather than pay more at a later date?

Here's the rub. Governments are not popular when they increase taxes, so they don't. They borrow and pay back later. Investors have confidence that no matter what happens, the Government will find the money to pay them back as promised when the bonds are cashed in at the end of the term.

If a Government doesn't, or can't pay back the money, then they "default". Much like you or I, when we fail to pay back a loan, our credit rating goes down and we find it more difficult to borrow in future. We are considered a higher risk because we have shown we don't pay when we must, therefore, with increased risk comes increased interest. You may find fewer lenders willing to offer you credit at reasonable rates if you have a poor credit history. You will probably get a loan, but at a much higher rate than someone who has never defaulted.

The same goes for countries. Investors will stop buying their bonds (or government debt as it is sometimes called), if they can't pay back when the bonds are due for redemption.

So, in prder for Governments to reduce their debt, and have the money to pay for the bonds that come due, they decrease public spending (usually public sector jobs and services) and increase taxation from the population.

This is where many countries are today, including the UK. It doesn't take a genius to work out that if one were to pay back a credit card using another credit card, there will be a point where it cannot continue. Governments such as Greece are doing just this, which is why they are needing "Bail-outs", or to put it another way, another financial institution promises to cover their debt, in the case of Greece, the European Central Bank and the IMF (amongst others).


What does that mean for the population?

It means that the Government needs the population to work harder, for less, to pay more in taxation to cover the debt. Investors know that the Government won't default unless it really has to, so they demand ever higher returns. 5%, 8%, in some cases such as Greece, 13%+ !

The population is taxed more, public sector jobs and services are cut, all to keep up with the debt. So for a worker within the UK, it is now up to you to pay back all that debt. You may have to get two jobs to pay your bills as they rise, take pay cuts or shorter hours (or both!) because credit is in short supply, and worst of all, you may borrow more to continue a lifestyle you are accustomed to.

All of this is bad news for an economy and for the citizen.


Inflation.

Inflation is simple. As time goes on, the money within a country increases. This is called "the money supply". The more fiat (or paper) money within an economic system, they less value it has. For instance, if grass was used for money, very soon, you would need mountains of it to pay for goods and services. This is because it's everywhere and if you need more, you grow some!

So grass would never work.

However if banknotes are very difficult to counterfeit, and everyone accepts them as money then that's fine. So we use paper money.

Over time, more and more paper money comes into circulation, not just through printing, but through the fractional reserve system. This means that a bank can lend money it doesn't have, by "creating" it from thin air.

Yes, it's absolutely true. They literally "print" new money and it's perfectly legal.

When you borrow from a bank for a car, house, boat, credit card, in fact anything, the bank opens a new loan account for you on a computer, and types in the amount you have borrowed. Then, you must pay that back over time plus interest.

This is why, over time, things get more expensive through inflation. If there's lots of new money getting into the system, the value of that money decreases, because iit's everywhere! Your £100 this year may buy 100 loaves of bread, but by next year, because of 5% inflation, those loaves now cost £1.05, so you will only get 95. If inflation stays at 5% the following year, then with your £100, you'll only get 91 (because they are now £1.10) and so on. This again is simplistic figures for easy reference, but the principle is correct.

Of course for Governments with bonds this is wonderful. High inflation is a tempting way to pay back bonds. Afer all, if the bond you issued for £100 is now worth £105, but your inflation is 10%, you actually win! However it doesn't work like that. As inflation increases, governments need to increase the return on the bonds because investors can see they won't make any money. The trick for an investor is to guess the right term length, with the state of the country, and if they have any doubt, then they turn to a new country to spend their money. Inflation kills investment leaving the taxpayer to cover the money not raised in selling bonds.

The upshot is....

As inflation and public debt rises, the population is forced to work harder, and some will lose their jobs. They are almost enslaved because at some point, the amount they are working doesn't give them the luxuries they work for such as holidays, nice clothes etc. they are literally working to eat, live and pay taxes.

This has happened many times in history, most recently in Zimbabwe where people saw their savings in banks worthless due to inflation. Don't forget, if you have £100 in the bank, unless the bank has a good interest rate to cover inflation, then you are losing money. Plus, if inflation is so high that very quickly you need that £100 to buy a loaf of bread, your savings have evaporated. This is why people buy assets such as houses, wine, gold, paintings, jewellry etc. As inflation goes up, so does the value of your investment, therefore protecting your wealth.

How many times have you heard someone say that "I bought this house in 1990 for £50,000 and now it's worth £150,000. I've made a £100,000 profit!" This is just nonsense. If that same person had've bought £50,000 of coal and stored them in a shed, today they would be worth £150,000. The house's value has not increased at all, the perception of increase is all that has happened. However, if you had put the £50,000 in the bank at poor interest, it would now perhaps be worth just £75,000. This is because inflation has taken it's toll on it. It is after all just pieces of paper, given a vlue because someone is willing to exchange something tangible for it such as goods or services.

Do not be fooled by this illusion. This is why when you put £100 in a pension pot today, when you retire in say, 40 years time, it will barely buy you a beer. So when you retire, you need a LOT of £100, and they rely on the markets to increase their value through investment in tangible assets and companies. This was one of the big pension scams of the 20th Century, which today is beginning to unravel at an alarming rate.

We are moving into a world of unemployment, no money, more debt and the workforce having to work harder for longer (yes that's why the retirement age has increased). There is no quick fix, so it's up to you as an individual how you deal with it. As I've said many times before, this is not difficult to understand, but if you make the effort you are many steps ahead of everyone else and will fair much better in the years ahead.

Good luck.

Kieran.