Lessons and challenge from the Spending Review
This article has been written by a renowned financial commentator. However, please note that we do not necessarily share his views, but we consider the substance of the commentary to be of importance.
In many ways the spending reductions made by the Chancellor were largely anticipated. The size of the current deficit has grown to over £160 billion this year and it was acknowledged by most that decisive action needed to be taken in order to head off a deeper deficit problem in years to come. While these cuts will take time to work their way into the marketplace the reality is that the economy is heading for a difficult period which is unlikely to end before the next Election – or maybe even the one after that.
It is easy to focus on the widely publicised reasons for the deficit which are normally advanced as being as a consequence of the global financial crisis, the cause of which we normally hear is the fault of the banks, and out of control public spending. While these no doubt share responsibility it is worth looking at our financial situation from other perspectives. In so doing we will, at times, look at a number of factors that it would be wise to consider when reviewing your planning.
In 2004 household debt (unsecured debt and mortgages) surged through the £1 trillion (that is 1 followed by 18 noughts) barrier. How long did it take to reach that level? Let us assume that it is 50 years. But, it took less than five years for that debt level to increase by over 50 percent. Immediately before the recession the average unsecured household debt was in excess of £22,000 (source: Credit Action). That statistic eliminates those households where there was no unsecured debt. While savings interest rates have collapsed in the last two years credit cards and store cards continue to charge rates of about 18 and 25% APR respectively on this unsecured debt.
In the last two years this debt has reduced to a current level of £18,000.
If these reductions continue then household expenditure will continue to be reduced by the ‘investment’ in debt repayment.
Thus, where the economy previously benefited from people extending credit that is no longer the case.
In the meantime government debt has recently tripped over the £1 trillion barrier and is set to increase to £1.4 trillion by 2014, notwithstanding the cuts announced in 2010. Like many households, the government now has introduced a spending budget that dictates that the increase in debt will be reined back. Once the increase in debt has been reined in we will still face the further impact of debt repayment.
So what does the future hold for debt? Debt has now become unfashionable and while we are unlikely ever to be a debt free society, the fact is that the economy is unlikely in the short term to ‘benefit’ from the plastic economy to the extent that it has done in the past.
In the early nineties the household savings rate was in excess of 10 percent, as it was in both France and Germany. However while the savings rate for both these countries has remained almost constantly in excess of 10 percent the savings rate in the UK fell to less than zero during the recession only to recover to just in excess of four percent last year. Everyone accepts that savings need to increase in order to provide financial stability and the prospect of future security. The media oft report on pension deficits, the uncertainty of stock market investments, the perceived lack of security in financial institutions and the poor annuity returns – it is hard to find incentives to promote saving. Yet, if retirement remains a certain prospect, as surely it does, then at some point we must all look realistically at what is expected in retirement and ask what has to be done to store up something for the golden years.
While the government has committed itself to the state pension the fact is that the basic income a couple can expect from the state is just over £156 a week or £8,120 a year.
The affect on the economy? Surely we will all be saving more and therefore spending less?
After the war it was possible to buy a house for a few hundred pounds. In the seventies houses could be acquired for between £5,000 and £10,000. Today the average cost of a terraced house is £186,000 and a detached house £330,000. With average earnings just in excess of £27,000 it is hard to see how first time buyers can buy a house when maybe there mortgage capability is less than £100,000. Those who have property are, to a large extent, protected from the challenges of the property market. After all the proportion of the budget allocated to repaying the mortgage has fallen from about 50 percent to 30 percent with the reduced level of interest rates.
The Prospect for Business
With a tough economy likely to get tougher there has never been a more important time to look at your plans and the businesses ability to:
Maintain and grow business margin
Increase the top line
Provide an increasing personal income
Provide funds to help provide for a healthy retirement
Increase in your net worth
What do your plans look like for 2011 and beyond?
The Comprehensive Spending Review in Perspective
The last government managed to increase publicly funded employees by over one million. They managed to achieve this by spending a seemingly ever-increasing tax revenue – to some extent generated by city financial institutions which, in turn, funded the Labour Government’s propensity for increasing welfare benefits (the nanny state) and funding ‘schemes’. The thirteen years the Labour Government was at the helm saw a rapid increase in the population largely due to the growth in the number of immigrants. Some perceive that this has increased the strain on the public purse with the welfare system paying out benefits – child benefit, child tax credit and working tax credit in particular. Currently the welfare bill (£194 billion) now absorbs all the government’s income from income tax and corporation tax (£193 billion).
What are the implications?
While we must all leave the Government to balance the country’s books it is clear that businesses and households must also do the same.
The government foresee 500,000 people losing their status as public employees. What will happen to those people? Well, on the basis that these redundancies will happen over the next four years there will probably be no spike in the unemployment figures. But, only time will tell how over optimistic the government is in believing that new jobs will be recreated. To the extent that people are unable to find work, relocate for new jobs or retrain there will be the added cost of welfare for those people. How many over 50s believe that they are ‘highly employable’? Will those who have previously been employed by the public sector be able to adapt to the private sector? How many will flex their entrepreneurial skills? At this [early] stage. We do not know.
What does all this mean for you?
Some of the content above is capable of being presented or viewed in a variety of ways. However it is a fact that probably 95 percent of the population will be impacted financially in the next few years and that impact will be hard. Realistically, there will also be a proportion of the population that will never succeed in elevating themselves above the poverty trap. The rest of us need to take a long hard look at our financial situation and look not just at today, but at tomorrow and the day after. The view you should take includes:
Is your budget balanced?
Where can you reduce your outgoings?
How can you increase your income?
Are you repaying unsecured [expensive] debt?
Do you have emergency funds (say, £1000)?
Do you know what income you will require when you retire?
Are you saving enough?
Are you minimising your tax?
You may have further questions than the above as indeed you recognise you may have different views. We would encourage you to meet with us if the above has raised any concerns. We are ready, qualified and able to help you with a Comprehensive Financial Health Check Up.