Gold and Fiscal Policy
What is Fiscal Policy?
The Encyclopaedia Britannica defines Fiscal Policy as:
measures employed by governments to stabilise the economy, specifically by manipulating the levels and allocations of taxes and government expenditures. Fiscal measures are frequently used in tandem with monetary policy to achieve certain goals.
Put simply it is how much a government taxes and how much it spends. Let’s take the UK as an example. The following graphic from the UK OBR (Office of Budget Responsibility) nicely illustrates where the UK Government receives its income from:
In total, approximately £811 billion is due to be received in the fiscal year. This represents just over a third of the whole economy. Now let’s have a look at where that money goes:
Spending is at a level of almost £841 billion. Therefore, there is a gap or “deficit” of £30billion. The government is spending more (£841bio) than it is taking in income (GBP911bio) in this year. The cash to cover this deficit is borrowed on the financial markets, by issuing debt securities. And this is where monetary policy comes in to play, we will come back to this soon.
For now, let’s focus on spending. Debt interest, which is the interest the government has to pay on the debt it has previously issued is approximately £51billion. That is just the interest, i.e., the cost of borrowing.
So, we can see now why when a government borrows a lot it would prefer to pay the lowest interest rate possible. Also, governments can refinance existing debt at lower rates as interest declines.
And who sets interest rates? In many advanced economies, there is a separation of the government and monetary policy decision–making. To what degree there is actual separation is hotly debated. Obviously, there is frequently pressure from the government of the day to ensure interest rates remain as low as possible for all borrowers.
In the UK example, which has been repeated in nearly all Western economies, the deficit has tended to become larger than in previous times.
This can also be illustrated in this way.
Basically, debt has been going up for a prolonged period of time. Why is that? Again, this is hotly debated. One potential answer is the rise of the social or welfare state. Since the 1950s, politicians have promised, and electorates have expected, significant amounts of money spent on education and healthcare. On the other side of the ledger, economic growth has not kept up to the pace to keep tax receipts sufficient to meet this expenditure.
Additionally, spending on social security, such as pensions, has increased as healthcare has improved, and life expectancy has risen.
Thus, according to the ONS (UK Office of National Statistics) the UK Total debt is currently:
General government gross debt was £1,876.8 billion at the end of the financial year ending (FYE) 2020, equivalent to 84.6% of gross domestic product (GDP), and 24.6 percentage points above the reference value of 60.0% set out in the protocol on the excessive deficit procedure.
Government debt is just accumulated deficits not yet paid off plus interest costs. It is easy to see how debt can so out of control over a long period of time. Especially when politicians’ careers are far shorter than the maturities of the debt being issued.
Governments raise money from the tax system to spend on the promises and obligations they make to the electorate, and to their debt holders. This is fiscal policy. When fiscal policy cannot raise sufficient funds for those obligations (spending) then monetary policy comes into play.
When Fiscal Falls Short
Governments throughout the planet, and throughout history have a terrible record of keeping borrowing under control. Whether it is waste, unproductive projects, wars or just bad discipline or inefficient tax collection, the inability to pay all expenses via only receipts from tax is fairly rare.
It is thus clear that when fiscal policy cannot raise the cash required, “other means” are utilised. This is why understanding fiscal policy is so crucial to understanding what monetary policy does.
These “other means” are essentially monetary measures. Some of these measures are borrowing from financial markets. This is an ordinary monetary policy. Others are deemed more extraordinary. Such as quantitative easing, or the central bank funding the government from its “unlimited” balance sheet.
Monetary policy is discussed at greater length throughout the Goldex Academy. However, the ultimate consequence of government deficits and thus borrowing, and thus extraordinary measures such as QE all serve to devalue the currency in question, and thus increase the value of Gold.
This is why there is such a debate now about the role of central banks, their balance sheet expansion, their extraordinary measures, their asset purchases, their lowering of interest rates to zero or even negative. Is this helping governments or creating more issues for the future? If a government can access newly printed for free, then what is the incentive to ensure fiscal discipline?
History has shown, time and time again, when this road of fiscal deficits leads to monetary debasement Gold tends to rise. It is why investors always ensure they have a keen eye on government borrowing statistics as well as the interest rate required to borrow again. It is why investors also follow the political manifestos of political parties to see if they commit to balance the books or to spend and borrow more.
If it is the latter, then investors will tend to decrease their allocations to that currency and protect their wealth with a further increase in their Gold holdings.