Okay. Welcome back to Garys Economics.

Today

we are going to ask

the question is the UK government bankrupt?

Okay.

So we are doing an emergency shoot today

on Friday the 10th of January

because I wanted to cover

this developing situation,

which could end up being really significant.

I don't think it's being covered very well on the news

and I wanted to make sure you understood

what's happening.

So this story is mainly about the interest rate

that the government has to pay when it borrows money.

And that interest rate

has been gradually increasing over the

course of the last year.

That interest rate has been gradually increasing

for the last sort of three, four months.

And it's increased really aggressively

in the last few weeks.

The interest rate that the

government has to pay at the moment, right now

is about 4.83%.

And that is raising questions

about basically whether the UK government

is financially sustainable, essentially.

And it's very realistically possible

that these sudden increases in UK

government borrowing rates

will force the UK government

into basically making emergency cuts in its spending.

Which you probably could describe

as a return to austerity.

But I think the most important thing

is, first of all, we explain really clearly

what is happening here

and why is

that an interest rate of just under

5% is so dangerous for the UK.

So if you look historically and I've got a graph here

and I think we'll pop them up,

If you look at historical

interest rates that the UK government paid,

on its borrowings,

the current rate,

which is just under 5%, was super,

super normal in the 2000’s before the financial crisis.

And if you go back to the 90s,

they used to pay significantly higher rates or 6%,

7% back in the 80s, even higher rates than that.

So why is it that now

that the

rate is just under 5%,

people are really worried

about the UK financial situation?

In order to explain that,

we need to talk about why it is

that governments are able to borrow every year.

So governments do this really interesting thing

where pretty much every year

they spend more than they tax,

which means they borrow money every year.

And yet the amount of debt that they have

as a proportion of GDP,

as a proportion of the size of the total economy

often doesn't go up.

So how do governments do this kind of magic trick

where they borrow money every year,

and yet their debt doesn't go up?

Okay, so the key thing that you want

to understand about debt

is that

what matters for government

financial sustainability

is not so much the size of the debt itself.

It's the size of the debt

compared to the overall size of the economy, which

we usually call GDP.

So.

The government borrows more money

every year, which causes debt to go up.

And the reason they get away with this

is because GDP is also constantly increasing.

Now why is GDP increasing.

So GDP growth can be broken down into two things.

The first one is the thing

that you often hear about in the news,

which is economic growth.

So you know,

the UK economy at the moment is growing

about 1% a year.

But one other reason

that governments get away borrowing more every year

is inflation.

Now,

what you need to understand about inflation is,

inflation doesn't affect the size of your debt.

So if you borrow money from the bank,

you borrow, say, £1,000.

You have to pay back £1,000 plus 5% interest.

That's £1,050..

That is £1,050. No matter what inflation is.

So if inflation is really, really high, say 20%,

you're only paying 5% interest.

But the price of everything else is going up.

The people's wages are going up.

The goods and services are going up.

Food, energy is going up.

So inflation also causes

GDP to rise.

One way to think about this is that

inflation is the devaluation of money.

If you want to think about that, you can get the,

you can watch the devaluation of money

video on our channel.

But inflation causes

GDP to rise and it doesn't cause debt to rise.

So basically

GDP has this double boost,

double boost, one from economic growth

and one from inflation.

And that means that debt can afford to rise

without debt over GDP from increasing.

The problem we have with debt

is that we have to pay interest.

So essentially there's three forces here.

Interest.

Pushes your debt up.

And inflation

and growth.

Push your GDP up.

So really what matters is comparing these three things.

Okay. So what's inflation.

So inflation was very high the last few years.

But at the moment

inflation is down back to around target.

It's currently around 3%.

But the Bank of England targets inflation at 2%, 2.5%.

Well its target is actually 2%.

But if you look historically

it does tend to be a bit higher than that over time.

If we assume that the Bank of England

slightly misses its target

and long term inflation is 2.5%,

that helps us because it’s going to keep GDP rising.

Growth at the moment, and

this is the big problem in the UK, is only 1%.

Add these two things together

3.5%.

Excuse my terrible handwriting.

What's debt interest now?

Debt interest is changing literally

while I make the video.

Debt interest

at the moment is 4.86%.

This is your big problem.

4.96% is

significantly more than 3.5%,

which means

unless the government

does something managed to increase growth,

the debt is going to grow faster than GDP over time.

And debt as a proportion of GDP is going to grow.

The only way for them to prevent

that from happening is either to increase inflation,

to increase economic growth,

get the interest rate down,

or it has to run a budget surplus,

which basically means taxing from you

more than it gives to you in spending.

in a sense, this makes it clear why

the financial situation

after, for example,

2008, when government debt increased significantly,

was less worrying

than, from the perspective of, say,

the UK than it is now.

And that is because after 2008,

we had this very, very long

period of basically zero interest rates,

which meant that the government could borrow,

at sort of 2%, even 1% at times.

And since inflation is around 2%,

if you can borrow at 1%,

that debt is just going to stay quite stable.

It's going to go up by 1% every year

and down by 2% every year.

And effectively,

the government basically pays no interest at all.

But as these interest rates push up

more and more and more and more and more.

It creates this potential

for a negative kind of debt spiral dynamic.

And I've been watching these interest rates

because a normal rate of sort

of inflation plus growth is something like

3.5%, maybe 4%.

As it starts to rise above 4%,

it gets more and more worrying

Okay.

So that's your explanation

of how to understand

basically whether the government interest rate

is a problem or not.

You need to understand what is

GDP growth at the moment it’s around 1%.

Of course, Labour

would like you to think it's going to go higher

and maybe it will.

Inflation is probably around 2%, 2.5%.

So as long as interest rates

are pushing above four and a half, the higher

they get, the more difficult it will be.

And if the government doesn't want debt

to increase over time,

it has no choice basically,

but to start taxing more than it spends.

Basically extracting that money from ordinary people.

So this has become

a big

talking point in financial markets

in the last few days.

The first thing I will say is

people are obviously going to compare this

to the Liz Truss situation.

That is pretty unfair.

I think the Liz Truss situation was really chaotic,

and it was

basically brought upon itself by some wild decisions

by Liz Truss and her government.

What has happened here is

the UK was already in a difficult situation

because the debt was increased

so significantly during Covid,

and they sort of tried to toe this middle ground of,

we're not going to tax the rich more,

we're going to borrow, we're going to be sensible.

Whenever your plan is based on borrowing,

there's always the risk that interest rates will go up.

In the last few months, interest rates have increased

all around the world,

and the government has been kind of using

that to defend itself.

They're saying this is not a UK government mistake.

This is moves in global interest rates.

It's caused by,

people are a bit worried about what Donald Trump

might do when it comes in.

That is all true.

But the fact of the matter is.

With interest rates where they are at the moment,

it is very possible

the government can't afford to fund itself long term.

And that is why a move in global interest rates

that have pushed

everybody's borrowing rates up

has hit specifically the UK.

And we can explain that,

why it's the UK specifically,

largely by showing you a list.

And I'll bring this list up

of what different countries in the world pay to borrow.

So you can see here

comparing the UK to European countries,

the UK pays about 4.83%.

The highest rate paid by any other large

European country is Italy, which is 3.74%,

which is a fall more than 1% below.

Now remember, growth

plus inflation is probably going to be about 3.5%, 4%.

So Italy at 3.74%,

that growth is not going to grow over...

that debt is not going to grow over time

as a percentage of the economy.

Whereas that UK number 4.83%,

potentially will grow as a percentage of the economy.

Okay, so the UK situation is particularly bad.

Interest rates go pushed up across the world.

Traders start to look at that UK

number 4.93% and question

whether the UK financial situation is sustainable.

That caused on, well,

yesterday morning, Thursday morning,

a bit of a panic in markets. The bonds started sell.

The interest rates started to rise quickly.

What does that mean for you.

What does that mean for the government?

The government cannot allow a panic

to occur in these bond markets because

if that rate starts to rise, really quickly,

if it rises to 5.1%, 5.2%, 5.3%,

every little bit that goes up

makes it more questionable

whether the government can afford to fund itself.

And as it becomes more and more questionable

whether the government can fund itself,

the borrowers want higher and higher rates

because they're worried that the government

won’t be able to pay it back.

And that creates a real risk for a negative spiral.

You know, we all saw what happened to Liz Truss.

The government's made a big deal out of Liz Truss.

The government absolutely need to prevent this.

So what can the government do?

What will the government do?

Financial markets will basically demand,

that the government

reduce their deficit.

You can reduce your deficit in two ways.

You can either increase taxes or you can cut spending.

If the government is forced to do something

very quickly,

it's very unlikely

that they have done the preparation

for a wide variety of tax rises.

They will probably be forced to cut spending.

That would be so devastating

politically for an already unpopular government.

Who made a lot out of Liz Truss's failings

that they will probably do anything to avoid it.

And what they will do

and what they have been doing over

the last couple of days

is basically really aggressively

trying to wink at the financial markets and say,

we're going to do the cuts, but

wait till March.

And the reason they want to do that

is because when March is

when the next sort of fiscal statement is

they want it to look orderly.

They want to say, listen, in the last few months,

interest rates have risen.

We're responding and we're cutting.

They don't want to seem like it's

a kind of a second Liz Truss moment.

Now this plays into something

which Labour made a lot

about in their election campaign,

which is Labour's fiscal rules.

There's a few fiscal rules,

but the one that is most relevant here

is that Labour have promised to stabilise this thing,

which we have been speaking about in this whole video.

They want to stabilise debt

as a proportion of GDP,

as a proportion of the overall economy.

As we discussed before, debt rises with interest.

So as the interest rate goes up,

unless you can get GDP growth out of somewhere,

the only way to stop the debt from rising

as a percentage of your GDP is to have inflation

or basically to cut your deficit,

to start taxing more, to reduce your spending.

So the government,

if they want to follow their own fiscal rules,

they basically cannot help

but be driven by financial markets.

If something happens like has happened

in this last couple of weeks,

and interest rates rise significantly

because the government has set this fiscal rule,

the government basically has to do cuts.

And unless financial markets turn around quickly,

it's going up, going up as I speak,

unless financial markets turn around quickly.

Really, there's only

two possible things that can happen,

which is the government manages

to convince markets to wait till March,

does its cuts in March.

Or if things get really bad

in the next couple of weeks,

the government might even be forced

to do some kind of emergency statement

where they, where they announce cuts.

Basically.

Either way,

the financial markets are going to enforce austerity

again on you by your government Okay.

Now I'm covering this now as it moves.

And I don't want to like,

panic people.

This could go one of two ways, right?

Either the market calms down in the next few weeks.

The government is able to wait till March,

or it keeps going,

and the government is forced to

do cuts more imminently.

Either way, this means austerity.

If this goes the most serious way

and I don't think this is probable,

but it's definitely possible.

If it calls Starmer and Reeves out

to make an emergency statement of cuts,

given how little political capital they have.

It could potentially

end the Starmer, Reeves government.

I don't think they would replace them immediately.

But

it could leave them in a sort of Theresa

May situation where they're left on as a dead duck,

where it would look really bad.

It will look really, really bad

if they were forced to suddenly backtrack

in a similar way to Liz Truss did.

And to be fair,

I think they would be unlucky if that happened,

because what they have done...

and I think this brings me to my next point,

which I wanted to make,

which is a lot of people in the media

will say

that this is because

especially if it gets more serious,

they will say that this is because of the budget.

The budget back last year.

And I think that would be

a pretty bad representation of what's really happening.

The budget was pretty f***ing mild in my opinion.

It was a pretty milk toast budget.

They slightly... they did slightly increased borrowing.

They slightly increased taxes,

they slightly increased spending.

But it was a very moderate budget.

And I don't think we should be surprised by that

because Starmer and Reeves are kind of defined

in a sense, by their economic sensibleness

and their economic moderation.

I think the problem that you have,

is that

the financial situation was pretty terrible coming in.

And, when I say this, you know,

I think I'm

sort of going to go down

the classic Labour line of, oh,

this is the Tories, blame the Tories, but

I'm not going to do that.

Really, what is happening now

is in a sense, the inevitable consequence is not of

the budget last year, but of the

really terrible economic mismanagement of Covid.

Now, if you go back, I mention it a lot...

look at the opening, the first video

we ever shot on this channel.

I spoke a lot about the massive accumulation of cash

by the rich and how that would cause

an inflation crisis and cost of living crisis

and an inequality crisis.

But one other thing that I mentioned there

was that

this money that went to the rich

came from the government,

and it would cause

and did cause a massive, massive increase

in government debt and a massive decrease in

basically government financial sustainability.

And at the time, it wasn't easy to know

whether that would lead to austerity or not.

And the reason for that is basically

because of the things

that we've discussed in this video.

After 2008,

we entered a period of extremely low interest rates,

which meant that the government could,

if it wanted, have continued to borrow and continue

to spend without really damaging

financial sustainability,

because when interest rates are very, very low,

they’re lower than inflation your government debt

simply cannot spiral out of control.

There was always the risk

when you massively increased your government debt

of coming into the kind of situation we are in now.

If interest rates ever go up,

then basically

your government becomes a slave to financial markets

and the financial markets can force you to cut.

The financial markets can force you

to reverse your policy.

That's what they did to Liz Truss.

That's what they did to Greece back in the 2010s.

This is an inevitable part

of allowing your financial situation to deteriorate.

And if you ask me, the real mistakes were made here

in 2020, 2021, 2022, when we knew

the government was going

to give an enormous amount of money out,

and we had a period of two years of lockdown

when we could have said, okay, who's

gonna end up with that money?

How are we going to get the money back?

How can we deal with our taxation policy?

How can we restore the government financial position?

And basically we didn't do it.

And I want to add to that, you know,

I'm not saying furlough shouldn't have happened.

I'm not saying the government didn't

need to spend an enormous amount of money.

That money was used to

give people the money they

need to pay their rent, to buy their food

when they weren't able to work.

We had three years to discuss the questions of

where's the money gone? Where's the money ended up?

How is it going to affect distribution?

Can we get the money back?

And really what you see here

is the result of a long period of phenomenal naivety

regarding the importance of resources.

Resources and distribution.

What you saw

during Covid

was the government

giving an enormous amount of money away.

That money went to the rich.

The rich can use that money

to buy the resources from the middle class, to buy

resources ordinary people need.

You've lost your resources.

I've said this before

and I'm going to say this again and again.

If you give all your resources away,

you are left with two choices.

Try and get your resources back,

which in this case means

finding ways to tax

the super rich who've got that money now,

or accept poverty.

And I think what we're seeing now is increasingly

this attempt at a third way,

which the current Labour government are trying

is not going to work.

It's not going to work.

It's possible that we get lucky.

Interest rates start to fall over the next

few weeks, months.

Now, inflation will fall over the next six months.

Bank of England base rates will very likely fall.

This situation could improve.

It's very, very difficult.

It's very, very, very difficult

to borrow your way out of a hole.

One thing I want to say is,

I know there'll be a lot of people here

that will say, listen,

we shouldn't let financial markets dominate our

government policy.

We shouldn't let financial markets

dominate our fiscal policy.

You know, I agree with that.

If you don't want financial markets

to dominate your governmental policy.

You cannot give all your resources to the rich

and have your financial plan be borrow them back.

This is what happens.

If you give all your resources away

and your plan is to borrow them back,

then you will be at the mercy

of the interest rates of the lenders,

the interest rates of the traders,

the interest rates of the rich.

The only way to defend your resources

once you've given them away

is to work on your taxation policy.

And we should be in a situation

now where we don't need to borrow from the rich

because we are able to tax

on the super rich

and use that to get our resources back

and use those resources

to provide the goods and services that you need.

But we're trying to toe this middle path of borrowing,

give all our resources away, try and borrow them back.

This is the risk that you take.

The last thing I want to say is,

I know that this crisis

looks quite UK specific at the moment.

There are a lot of countries

that are not further down the line on this.

The situation in the US is slightly better

because they have higher growth.

The situation in Australia is slightly better

because they have higher growth.

The situation in European countries is slightly better

because the interest rates are lower.

If interest rates keep going,

your country could be next.

You need to protect your resources.

The resources have been given to the rich.

If you don't fix your taxation policy,

you will have no choice but to slowly

shut down

your welfare states

and your countries

will look like impoverished countries,

like India, like South Africa, like Brazil.

Go to those countries. See how ordinary people live.

That can come here, that can come to your country,

that can come to my country.

I don't want to panic you.

This might resolve itself. This could get worse.

Living standards will keep deteriorating

unless we get our resources back.

That means taxing, not just borrowing.

Thanks for your help. Good luck.