It's Official - The UK Government Is Now Bankrupt

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Vanityfox451
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It's Official - The UK Government Is Now Bankrupt

You would think that news that the UK government is bankrupt would be headline news around the world. When I quote the piece of news that announces the bankruptcy, you may say 'huh?', and like the newspapers, initially find it difficult to see it. I will start with the news itself, which was tucked away in the financial section of the Telegraph:

'Charlie Bean [the Bank of England Deputy Governor] put his weight behind the pound's 25pc fall over the past year in an unusual comment on the pound. Mr Bean also confirmed that the Bank is poised to start buying government bonds in a drastic attempt to resuscitate the stricken economy.'

If we translate this, it means is that the Bank of England is going to print money to directly finance the operations of the UK government. This is the action of a government that is now literally bankrupt. The bank is not going to buy the bonds to 'resuscitate the stricken economy' but will buy them because nobody else wants to buy UK government bonds. There are not enough people willing to lend to the UK government. It is bust. It is bankrupt.

The UK government can not fund itself without borrowing - it can not service its existing debt without borrowing, and it can not pay for its activities without borrowing. When the lending stops, it goes bust. Or it prints money.

You will have read lots of stories that 'quantitative easing' (printing money) is being undertaken to fight deflation, but it is not. It is the last desperate gamble of governments to save themselves and their collapsing economies. For those that believe that printing money and lending it to the government is about fighting deflation, read on....

In July of last year, I posted that I believed that the UK government was effectively bankrupt, and that this would reveal itself as the coming crisis progressed. Ever since that early post, I have watched in horror as the UK government has poured ever more money into ever more and ever larger bailouts. In July of 2008 I had this to say:

One certainty is that, in a years time, the UK banking system will still be in crisis, as will be government finance. Unemployment will still be climbing, consumer confidence will be rock bottom, and house prices still falling. Businesses will be closing down in large numbers. All of these events were put in place over the last few years, and can not be reversed.


I identified that the first bailouts would be followed by even greater bailouts, and that the banking crisis would simply be transferred onto the government. As just one example, I asked the following at the start of September:


The reality is that the UK has been bailing out the banks for some while, through the special liquidity schemes. How long can this go on?

This was before even more money was poured into the bailouts. I then went on to say in the same post:

In the case of the UK, I wonder whether the UK government will have the financial wherewithal to actually have a choice in the matter. When the next credit crisis strikes, I expect confidence in the UK economy to be at a very, very low point, and the only way the government will be able to finance the bail outs will be through 'printing' money, with all of the negative consequences that entails.

As a sense of perspective, this was written at the time of the bailout of Fannie Mae and Freddie Mac in the US (I have added the italics in this quote). The situation that I predicted at that point in time is exactly the situation that is now confronting the UK.

In recent months I have also been pointing out the impossibility of continued government borrowing. In particular, just about every country in the OECD is going on a massive borrowing binge, and all at the same time. My question is very simple - how are all of these governments going to simultaneously raise the money to finance their borrowing? The US alone is looking to raise $US trillions. In such circumstances, potential lenders will have a huge range of choice on where they put their money, and they will look to put their money where they believe it will be safe.

As we are all aware, the £GB has been plunging in value, the UK is seen by many as the economy that will be hit hardest by the economic crisis, and (even before this article) was discussing the option of printing money. Amongst all of the choices of which country to lend to, the UK is going to towards the bottom of the list. At the same time, due to the lunatic and endless bailouts, government borrowing is spiralling ever higher. At a time when there is intense competition between countries for finance, with an ever growing need for ever more borrowing, it is inevitable that the UK government would be unable to continue to borrow enough money.

As a result, the printing presses are about to turn....

Back in December of 2007 I wrote a post called 'Money Printing Economics - the UK and US as the New Zimbabwe?'. At the time I wrote this, I could still put a question mark on the end of the sentence. This is what I said at that time:

Now we come to the crux of it. If the government prints enough money, this will provide an potentially unlimited amount of liquidity to the banking system, and the banks can then use that money to buy government debt, thus financing government borrowing. Meanwhile, the government can continue to service its expenses and keep repaying the debt owed to overseas creditors. In other words, the government will appear not to default. However, overseas investors will not see it this way. They will see it as it is - a default. Instead of failing to repay, they will be repaying the debt obligations in what can only be termed 'comedy money'.

As it is, the government is not even using the banking system as a conduit for the printed money, but will be financed directly by money fresh off the 'printing press'. Putting the situation bluntly - the UK is now the new Zimbabwe.

I have, in many posts, discussed the results, implications and consequences of printing money. If you would like to know how a central bank prints money, I give an explanation in Note 2 at the end of a post which can be found here. However, the method is not important, and it is just as easy to think about the central bank as if it were printing money by printing physical bank notes, as the effect is exactly the same.

I will try to explain what printing money actually means, through simplifying the process (for regular readers of the blog, you may want to skip the explanation, as I have explained this before). As we are all aware, the UK has an output of goods and services in many sectors. However, for the sake of simplification, I will just use the example of milk, and will describe the UK's output as if it were only milk, and will use small numbers to make it as clear and as easy to understand as possible.

In this illustration, we will say that the UK has a total output of milk of 100 litres, and that there is a total amount of £100 in the UK economy. In this example, therefore, the price of milk will be £1 per litre. If we then imagine that the government prints another £10, so that there is a total of £110 in the economy, we have a problem. The amount of milk has not increased at all, but the amount of money available to buy milk has increased. Instead of having £100 chasing the 100 litres of milk, we now have £110. In this simplification, remember, there is only the 100 litres of milk to buy with the money.

The only thing that can then happen is that the milk will increase in price from £1 per litre to £1.10 per litre. In other words, if you increase the money supply without increasing output, then you have a situation of inflation.

In addition to this, printing money has lots of other nasty effects. The first of these is that printing money is a form of taxation, and I will explain how this works.

As we have noted from the milk example, if you print money without increasing output, you are effectively devaluing money. Yesterday, your £1 could buy you a litre of milk, today that is not possible. If you are devaluing money, where has the value gone? The answer is that part of the value of your £1 has been transferred onto the newly printed money. If you then ask who has this newly printed money, you see that it is the government that holds it. As such, what you have is a situation in which the government is placing a tax on every unit of currency, and transferring that tax into the newly printed money. This means that there is a tax on every coin and banknote in your pocket, a tax on every £1 that you have in your bank account, and a tax on every asset that you hold that is denominated in the £. In other words, it is a tax on everything.

Another effect of printing money is that it a method for governments to default on debt. If you imagine that you are an overseas investor, and you have lent the UK government £1, then the value of that money was equivalent to being able to buy one litre of milk (using the milk example again). If you imagine that the government is running out of money, so that it has only £0.90 left to pay the lender, they will have a choice. Either they can pay back part of what they owe the investor, which means partially defaulting on the debt, or they can print money and give £1 to the investor. In the case of giving the lender £0.90, this is not enough to by a litre of milk, which means that the lender has lost money. However, if the government prints money, as in the example I gave earlier, then the investor will have his £1 returned, but it still will not buy the litre of milk, as milk has increased to £1.10. In both cases the effect is exactly the same, and in both cases the government has defaulted on debt.

Essentially, however it is spun, government money printing is fundamentally dishonest.

Then there are the effects that this has on an economy. Before discussing this, I have seen a lot written about Japan, and how they managed in recent times to print money without subsequent hyper-inflation. This is given as a justification for why it will be okay to print money in countries like the UK, and the US. If you go to my post here I explain why Japan 'got away with it', and if you go to the notes at the end of the post I explain why countries like the UK will not 'get away with it'.

Returning to the effects on the economy, we have established that inflation follows money printing. This is a situation of monetary inflation, where the output of goods and services is not increasing, but where the number of units of money chasing those goods is increasing. What then happens is that the cost of living goes up, as everything becomes more expensive. In a situation of a collapsing economy (the case of the UK), many private sector workers will be very upset at seeing their standard of living eroded, and some of them may be brave enough to strike and demand more pay. Many others will not, as they will fear for their jobs. However, some of those strikers will actually get more pay. That increase in pay will feed into higher costs and eventually higher prices for the output of their sector. This is inflationary.

In the meantime, government workers will also be upset at seeing their standard of living declining. The difference here is that, they will not have the same fear for their jobs as the private sector, and will therefore be more likely to strike. As they are in the position of running 'essential services', and/or the unions in this sector are strong and powerful, they are very likely to succeed in gaining pay rises. If we remember why the government is printing money in the first place, which is because it can not afford to pay for its commitments, it becomes apparent that this will be very problematic. The government is already unable to pay these government workers without printing money, so paying them more means that they will have to print even more money......which further feeds into inflation.

All the while this is going on, the government is effectively devaluing the currency, such that on foreign exchange markets the value of the £GB will be falling. As the value of the £GB falls, the cost of all imports will climb. Again, you have substantial inflation. On top of this, as the inflation starts to kick in, you start having capital flight, which is where people realise that the value of their money is being destroyed, so that they seek to put their money in other currencies that are more likely to hold their value. In order to do this, they will have to sell their £GB in exchange for other currencies, which means that there is a flood of £GB into the world market, which in turn further pushes the value of the currency down even faster and harder. This in turn feeds into higher inflation, and the situation becomes self-perpetuating into a downwards spiral.

So what will the government do with inflation out of control and a collapsing currency? Inevitably there will be widespread discontent and hardship that results from this inflation. The government is in a position where they believe they must 'do something'. On past performance, based upon the way that they have systematically destroyed the UK economy such that they created the situation, they will yet again do exactly the wrong thing. They will try to command the economy back into shape. In order to do this, they will impose controls on international capital flows to try to lock capital into the country. They will also impose price and wage controls to try to stem the inflation.

Of all of these, the most worrying of the possible actions will be the price controls. In particular, it is very likely that they will try to impose controls on the price of food and energy, as the inflation in the price of these items will be the most immediate concern. Price controls, unfortunately, will always result in even greater problems than they are supposed to solve. All you have to do is think of yourself as a dairy farmer, for example and imagine that the government decides that you can not increase the price you charge for milk (sorry, back to milk again).

In this situation, you will see the economy inflating around you, but you will not be able to inflate your milk prices at the same rate. This means that you will be becoming poorer, as the value of the milk you sell will be falling relative to everything else. In this situation, it becomes increasingly pointless to actually continue in the business of selling milk, because you will start to lose money. As a result, the output in your sector will fall, and then there will be shortages.

It is at this point that the situation is completely out of control, with the government imposing ever more 'controls' on ever larger parts of the economy. What happens then, I am not sure...but I do not think it will be a happy situation.

This last section is speculation based upon my best guess of what the government will do. It is also possible that someone will have the courage to lead the government out of its self-created crisis. The answer, of course, is to switch off the printing presses, and accept a period of significant hardship and austerity. However, my speculation is based upon the action of the government to date, in which they have continually sought to pretend that they can control the economy and turn back the clock to the 'good times'.

I have mentioned a couple of times in this blog that I sometime have difficult believing the implication of what I am myself writing. In particular, the rational part of me says 'this is the reality', but the irrational part of me refuses to believe it. Occasionally, such as seeing the article quoted at the start of this post, reality is hammered home. In this case the reality is that the government is now going to try to finance its operations through printing money. This really is the Zimbabwe solution, and however many economists witter on about various justifications, funding a government with printed money is a road to disaster.

The real tragedy of this is that it was completely avoidable. Whatever happened, the UK was going to have to face a very hard time, but there was never any need for it to become as bad as it will become. If the government had shown the courage of leadership, had accepted the underlying reality of the depth of economic problems, it could have set about the essential reform of the UK economy. Instead of this, they chose to delude themselves, and delude the public into thinking that everything could go on as before.

Another tragedy lies in the media. They should be screaming with outrage at what the government is doing, but instead they are wittering about bankers bonuses, and other populist nonsense. They have let themselves be steered away from the reality of exactly what is going on. As I said at the start of the post, the UK government has now effectively declared its bankruptcy, but the headlines in two of the major UK newspapers are 'Archbishop: Christians are seen as mad by society' and 'US agents charge cricket mogul with $8 billion fraud'.

Quite simply, I despair.....

Note 1: I found an interesting article in the Telegraph, in which they report the following:

 

Last month, the Institute for Fiscal Studies warned that it will take more than 20 years to pay off the debts being run up by the Government during the current crisis.

Calculating that public debt had already risen by £10,000 for every family in the country, the IFS warned of a "tightening" on tax and spending that will have to continue until the early 2030s.

 

If nothing else, it gives a good sense of scale to the lunacy (italic and bold added by me).

Note 2: In the unlikely event that governments were actually able to meet their insane level of borrowing, just think about the impact of that borrowing on the world economy. For simplicity, we will pretend, for a moment that there is no money printing, and imagine that the total amount of money in the world economy is therefore fixed. If you then were to imagine that the world economy has a total of 1 million units of money, and then think of what governments are doing, the insanity of their actions becomes apparent. Effectively, they taking ever larger slices of that pile of money into their hands for their various stimuli. As such, if the government borrows 500,000 of the total units of money available, then there is 500,000 less available for investment in business. If there is less investment in business, then there is less growth in the world economy.

In the meantime, the 500,000 units of the total is being spent by the government propping up insolvent business (banks, automakers etc.), and being spent in areas that will not create any long term economic growth. In other words, it will be spent on activity which will not solve any problems at all, except in the very short term. By denying this money to private business, they are simply restricting the potential for growth in business overall, and thereby destroy the chances of eventual recovery.

Note 3: Arguments against this post are very welcome. I really would like to believe that I am wrong. If you can convince me I am wrong, I will be genuinely grateful. I really, really do not want to be right.

Note 4: I remember a comment which mentioned that the blog is very popular with farmers. My suggestion to farmers is that they organise and prepare to defend themselves against price controls - have the arguments ready, and if need be, have plans to face down the government. The same for the energy sector. I could be wrong about price controls, as there is no deterministic reason for them, and this is speculating on what actions individuals might decide on. However, bearing in mind that such price controls would devastate your businesses, you may want to take a precautionary approach, and prepare anyway. My best guess is that such controls might appear in about a years time if that is the course that is followed, but that is nothing more than a wild guess

http://cynicuseconomicus.blogspot.com/2009/02/its-official-uk-government-is-now.html

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eb_riesling
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Re: It's Official - The UK Government Is Now Bankrupt

Vanity Fox451,

Thank you for that post.  Exceptionally well done.  Your explanations on complex issues approaches our grand master here.  I find it fascinating now when I look back at the UK.  I am an ex auto industry bloke.  I am Canadian and when I travelled to all my suppliers or called upon UK car companies I often found my self wondering how people in the UK survived with the prices they had to pay for things.  Yet at the time, when I compared the Economists world rankings for GDP/P Canada was no where near the top but going home I found it soooo much cheaper it never added up?  It does now.  The stats were fixed and manipulated much as all governments are doing today.  The gig is finally up.

I have since let my long time subscription to the economist expire ( they got this fiasco and oil so fundamentally wrong whats the point)

What's your take on gold?  Will governments have no choice but to eventually go back to a gold standard or will they run us into the ground?  Do you think a secondary currency can start in parallel (such as those hold gold sites) with credit cards issues in gold and transactions get deducted from it?

 

Thanks again,

 

E

 

 

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Re: It's Official - The UK Government Is Now Bankrupt

Great post. Basically you've pulled together and summed up alot of my concerns about our current situation - thanks. 

You put the blame squarely on the government and I can understand why. But what about the voters? Any politician who stands up and tells it like it is wont get into office. They promise us 'milk (that white stuff again) and honey' because if they didn't they wouldn't get elected. So part of the blame rests with us, not just our feckless leaders.You could blame the government that our education system hasn't prepared people adequately to understand basic economics (or human biology for that matter), but its not all down to the government.

It reminds me of the great Paul Weller's lyric from Going Underground, "The public gets what the public wants, But I want nothing this society's got".

Freddy

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Re: It's Official - The UK Government Is Now Bankrupt

Hello Walden

I agree with you assuming that society reads and learns about what is going on.  In general, humanity likes habits and being led and comfort the polititions knows this fact.

Most people in politics have been trained since 16 years old ((being in the young Democrat or Republican groups)), have political science under graduate degrees and become lawyers.  All this time, they are trained by colleges and there respective parties about manipulation of humans.  What to say and how to say it.  So they generally, become good at deflecting questions, avoiding the truth that would hurt them, or answering any question at all directly.  Therefore by the time the stuff hits the fan, we are so blind sided that we are in a state of shock.  In this time, the polititions already have a garbage answer for what happened and the uninformed humans beleive whatever is said and beg for help.

So it is our job to try and wake people up the best we can.  To let people have a chance to make informed decisions and plan.  In a nut shell, that is what the crash course is all about from my view point.

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Re: It's Official - The UK Government Is Now Bankrupt
eb_riesling wrote:

What's your take on gold?  Will governments have no choice but to eventually go back to a gold standard or will they run us into the ground?  Thanks again,

E

Hello E -

This is a very narrow slice of a layered onion.

Consider the US debt of 53 - 65 trillion dollars when you take out the fuzzy factors. For argument's sake, let's say $58T.

Current gold inventory is around 262 million ounces.

Just to have backing sufficient to cover the debt, gold would have to go to around $222,000 an ounce.

I don't think we can go back to a gold standard. At least not until the economy implodes and we start over.

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Re: It's Official - The UK Government Is Now Bankrupt
Vanityfox451...
Applaud your post. 
My take...
1.)  All governments are desperately reacting in futile attempts at maintaining the status quo.  The UK is only one.
2.)  This is resulting in the abandonment of common sense human principles and values.   Instead, they are defaulting to past events that no longer apply.    Which they should know.   Examples:  Great Depression, Japan, Sweden, etc.
3.)  Real solutions require tough choices of improved efficiencies and effectiveness.  Incentives and innovation that by their nature conflicts with government and business institutions and current lifestyles.  Until there is enough economic hurt probably requiring societal and political unrest...will this facilitate true solutions.
Thus...do we really have leaders at this time?     Their actions define their character...which ties into their true belief systems of morals, values and principles.   Amazing how human history this is proved over and over.   Principle-based, selfless leaders or egotistical, power-based rheteric?   This is where checks and balances, transparency and accountability.   
Simply put, in the big picture...are their actions consistent with sustainability?   Your post correctly makes the case against.
Don't lose faith...when enough people are fed up enough...they will be open to enduring, principle-based change.   Not the "hype" Obama's and other "leaders" actions...err reactions.
If your not clear how this can be done, just ask.
Nichoman
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Vanityfox451
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Re: Gold Standard

Hello Eb_Reisling,

I can only take credit for what Davos says on his Digest that I simply Cut and Pasted this and it took all but a few moments to achieve. The author of this piece keeps a well oiled blog written that I use as a reliable gauge as to what is going wrong with the financial world at this time.

As for re-committing to a 'Gold Standard' again, I have my suspicions that there is just too much (fiat) paper money floating around and gold would only be accredited to about 3% of the value at this time.  

A recent thread I created by the same author makes for intense reading and drew a great deal of attention :- 

The Climax Of The Fall Is Now In View

http://www.peakprosperity.com/forum/climax-fall-now-view/11976

Take Care,

Paul

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Re: It's Official - The UK Government Is Now Bankrupt

"You put the blame squarely on the government and I can understand why.
But what about the voters? Any politician who stands up and tells it
like it is wont get into office."

Hmmm....  except that in the face of the bleedin' obvious they just might.  Don't you think that once everything craps out the people will never believe a conventional (ie partied) politician, but would have no choice but to believe an independent saying "we've all been conned"?

Mike 

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Damnthematrix
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Sweden refuses to play silly games...

Breaking ranks with corporate socialists around the world, Sweden
doesn't want to nationalise its car industry...

Saab speeds towards abyss
February 19, 2009 - 7:20AM

http://business.smh.com.au/business/20090219-8bnt.html

The future of Sweden's Saab Automobile looks more uncertain than ever
after it was abandoned by US carmaker General Motors and the Swedish
government refused to come to its rescue, despite impending bankruptcy.

"Prospects are really bad for them," Mikael Wickelgren, a car industry
expert and a professor at the University of Skoevde in southern Sweden,
told AFP.

Sweden's centre-right government reiterated that it had no intention of
taking over the beleaguered Saab automaker despite a warning from owner
GM that the unit could file for bankruptcy protection "as early as this
month" unless it received Swedish help.

"The Swedish state is not prepared to own car factories," Enterprise and
Energy Minister Maud Olofsson told reporters in Stockholm.

"We are not prepared to risk the taxpayers' money ... This is not a game
of Monopoly," she said, pointing out that GM had barely made a profit
from Saab in the two decades it had controlled the unit.

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Re: Sweden refuses to play silly games...

I`d love to see how faux news spins this. lol

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Re: It's Official - The UK Government Is Now Bankrupt
Damnthematrix wrote:

Hmmm....  except that in the face of the bleedin' obvious they just might.  Don't you think that once everything craps out the people will never believe a conventional (ie partied) politician, but would have no choice but to believe an independent saying "we've all been conned"?

Mike 

Maybe in Australia Mike.

Here in the good ole USA we have people who are such deep thinkers they depend on Oprah to tell them who to vote for rather than sorting out the candidates' stance on the issues.

We call them O-Bots.

H L Mencken said it best:  "Democracy is the theory that the common people know what they want and deserve to get it good and hard." 
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Re: It's Official - The UK Government Is Now Bankrupt
Dogs_In_A_Pile wrote:
eb_riesling wrote:

What's your take on gold?  Will governments have no choice but to eventually go back to a gold standard or will they run us into the ground?  Thanks again,
E

Hello E -
This is a very narrow slice of a layered onion.
Consider the US debt of 53 - 65 trillion dollars when you take out the fuzzy factors. For argument's sake, let's say $58T.
Current gold inventory is around 262 million ounces.
Just to have backing sufficient to cover the debt, gold would have to go to around $222,000 an ounce.
I don't think we can go back to a gold standard. At least not until the economy implodes and we start over.

 

 
To reintroduce a gold standard, you wouldn't bother to do it with the Fed's failed currency, you would introduce a new competitive currency in parallel to it, called say the US Standard Dollar ($USSD) or whatever you like. Fix it to a weight of gold eg. 1 US Standard Dollar = 1gm of gold. So to own a $USSD you would take a gram of gold  to an authorized bank and they would give you back a $USSD note.

So then if you are a merchant you put two prices on your goods ($US and $USSD),  just like when the Euro got introduced, and allow the customer to pay for their purchase in either currency. The market forces will dictate which one is prefered in the long term, without hving to muck around with the setup of the existing currency.

 

- Ernie.

 

 

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Re: It's Official - The UK Government Is Now Bankrupt

Ernie -

That makes too much sense.  Washington, DC will never go for it though - not until the "Idiot Collective" of Reid and Pelosi can put some kind of nanny state clause on it so their constituency will re-elect them.

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Re: It's Official - The UK Government Is Now Bankrupt

Hello mpelchat

I agree, the problem is how to educate/enlighten people who just don't want to know. When I finally made sense of the predicament we are in I sent the CC link to everyone I know. Now I like to think most of my friends aren't too shortsighted or dumb, but not one of them has finished the whole course. A super smart good friend came over last night and he'd only got to chapter 3 before he bailed out. And the CC is one of the most accessible formats and presentations out there!

I know this theme has been covered on numerous thread before so I wont go on too much, but it is a real problem how to wake people up. I wont stop trying though.If you've any good ideas, please share them.

Mike - I think your about right on that. Once everything starts to slide people will have to wake up and start asking more of our politicians. Maybe then we will can come to a better understanding our fundamental and fragile relationship with the earth.

Freddy

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Vanityfox451
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Re: It's Official - The UK Government Is Now Bankrupt

Hi Freddy,

I, and I think Mike will agree with me, have simply had to loose old friends and gain new ones. Literally, this fiasco we're drawing towards is that invasive, the very people you rely upon today are proving they aren't reliable for tomorrows lifestyle. I've simply lost count of how many people I know of that simply can't get the CC beyond chapter three at best. The future is a tough propersition when those you assumed would be there for you aren't coming along with you for the ride of a lifetime.

My Best,

Paul

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