Tuesday, September 2, 2008

UK Bankrupt? Does the market now realise?

Despite suggesting in my last post that I would move on to a discussion of regulation in the UK economy, I thought I should make a quick post in light of some of the latest headlines.

The first comes from the Telegraph, and the article reports:
'It is the first time a major international forecaster has explicitly said Britain is facing a technical recession, in which the economy contracts for two successive quarters.

Even more embarrassingly for Gordon Brown, the OECD forecast shows that Britain is the only major economy in the world which will face recession in the next six months. The warning severely undermines his claims that the UK is well-placed to withstand the global downturn.'

This is very much in accord with my earlier post in which I pointed out that the UK is uniquely poorly placed to weather the economic storm. However, I do believe that the OECD is being far too optimistic about the prospects for the other OECD economies. However, this is not about finding further vindication for my predictions but mentioned as further evidence of the loss of confidence in the UK economy.

The OECD appears to be waking up to the severity of the situation in the UK economy, and the market appears to be doing the same. The £ sterling is continuing to plunge, as is discussed in another article in the Telegraph:
'The pound's slump accelerated for a second day in London as traders abandoned British investments following Alistair Darling's warning that the economy is facing its worst threat for 60 years.' and 'The slump leaves the pound worth the least - against a basket of world currencies - in 12 years.'
Again, this is much as predicted but, more to the point, is a strong indicator of the loss of confidence in the UK economy. Finally, and perhaps most disturbing is yet another article from the Telegraph which indicates the terrible state of the British banks:
'The City's embattled banks packaged up the biggest amount of mortgage debt in history last quarter, in a desperate scramble to gain access to the Bank of England's Special Liquidity Scheme.'
The big question here is whether the UK government has accepted toxic waste from the banks in an effort to save the banks, or whether the swap was made against sound instruments. Even more pertinent is the question of the state of the UK banks in general. Many of these swaps have been made during the relatively 'good times', and this raises questions as to how bad the state of the banking sector might be now that times are getting tougher and tougher. I have suggested that there will be a further credit crisis in many of my posts, followed by a rash of bank failures, but perhaps the carnage will be greater than I previously thought.

I have quoted these articles and posts to highlight the gradual and accelerating loss of confidence in the UK Plc financial position. I have pointed out before that I believe that the UK is structurally bankrupt. By this I mean that the UK's ecternal debt exceeds the ability for the UK to ever repay the principle, and that it is increasingly impossible to pay the interest. There is simply not the productive capacity for export to achieve this.

The reason why confidence is so important is best explained through an analogy. The analogy is an 18th century aristocrat who is living beyond his means. He gambles, he entertains, and he has a wonderful time. All of the tradesmen extend to him long lines of credit, and he continues with his profligate lifestyle, all the time feeling that he is above the petty business of managing finance. After all, his family has been wealthy for generations, and it is his right to enjoy the good life. However, he is actually spending his family wealth, and the earnings from his estate are no longer covering the costs.

His creditors also know that his family have a long history of wealth, they see his fine house, they see his expensive furniture, his lavish lifestyle, and can not believe that he will not repay the credit that they are extending.

Then a rumour starts that he is in financial trouble. One or two of his creditors start to press for payment, and restrict his access to new credit. He is unable to make the payments. The word starts to go around that maybe he is not as solid a credit risk as everyone first thought. Creditors start to refuse to extend his credit further, and the aristocrat starts to realise that he has no money. The entertaining, the lavish clothes, all become beyond his means. He can no longer make repayments. His estate does not generate enough cash, and now that the credit has stopped, he can no longer afford anything at all. He is bankrupt.

The UK has long lived on such confidence but, like the aristocrat, it is a misplaced confidence. It is a confidence built upon an idea that wealth is a birthright. However, as the UK is about to learn, it is not a birthright, but something that requires effort and energy. You can only live so long on your inherited wealth before it is squandered away, and you can only live so long on credit before the creditors start to ask questions of your ability to make payments.

It is for this reason that I am looking so closely at news that indicates loss of confidence in the UK economy. As I have said, the UK is structurally bankrupt, and it is just a question of time before all the creditors start to notice. At that point, the UK will visit the IMF....


On another indirectly related issue, it is apparent that the government is considering a stamp duty 'holiday' in an attempt to revive the housing market. As I have pointed out in a previous post this suggests that the government has some special knowledge about what house prices should be. I will not rehash what I have already written, but would recommend you take a look at the post. It will highlight how absurd such intervention in the market actually is.


  1. The idea that although we have been bankrupt for a long time, foreigners have been prepared to lend money and 'invest' in the UK makes absolutely perfect sense to me. In fact, it explains the nagging doubt that I've always had at the back of my mind, wondering just how our lifestyles were sustained.

    I don't think many people understand, however. To them, the fact that they have always been working, saving, paying the rent and taxes means that, by definition, they have 'paid their way'. It would be difficult to persuade them that their whole working lives could have been spent on economic 'froth', made possible by a mass delusion.

    People only think in terms of ordinary human timescales, so that in their minds ten years is more than enough time for a complete 'flushing out' of the economy. They cannot conceive that a delusion could have perpetuated for decades, or even entire lifetimes.

  2. I have just read the latest installment of the 'Archdruid Report' http://thearchdruidreport.blogspot.com/
    and a section of it is not too far off the random meanderings I posted in a comment yesterday. However, he particularly emphasises the role of cheap energy in allowing the West to indulge in economically non-productive activities for decades.

    Here's the section I particularly noticed:

    "The flood of cheap abundant energy that surged through the industrial world during the twentieth century reshaped every dimension of the economy in its image, and nearly all the things we have grown up considering normal and natural are artifacts of that highly abnormal and unnatural state of affairs. Very few people in the industrial world today spend their workdays producing goods or providing necessary services; instead, pushing paper has become the standard employment, and preparation for a paper-pushing career the standard form of education. The once-mighty archipelago of trade schools that undergirded the rise of America as an industrial power sank with barely a trace in the second half of the twentieth century. I once lived three blocks away from the shell of one such school; it had been engulfed by a community college, and classrooms that once hummed with the busy noises of machine-shop equipment and the hiss of hot solder were being used to train a new generation of receptionists, brokers, and medical billing clerks

    The postindustrial economy proclaimed by Daniel Bell many years ago, and accepted as an accurate description of economic reality since then, was never much more than a shell game. The societies of the industrial world were every bit as dependent on industry as they had ever been; they simply exported the industries to Third World countries where labor was cheap and environmental regulation nonexistent, and continued to reap the benefits back home. Those arrangements only worked, however, because cheap abundant energy made transport costs negligible, and systematic distortions in patterns of exchange pumped wealth from the Third World to a handful of industrial nations, providing the latter with the wherewithal to pay a very large fraction of their populations to do jobs that don’t actually need to be done. As energy becomes scarce and expensive again, and the imperial systems that concentrated the world’s wealth in a minority of nations are shredded by the rise of new centers of power, those arrangements will break down. As that happens, a great many goods and necessary services now done offshore will need to be done at home once again, and a great many professions that produce no goods and provide no necessary services will likely drop off the economic map."

  3. Good comments Lemming! Thanks for the link to the archdruid report. Lots of interesting material there.

  4. This raises the philosophical question of whether you can "realise" something that isn't true.

    UK has a big external debt but is also a big external lender. Whether we're bankrupt or not depends on the net position. UK external assets are about 95% of UK external debt, so the problem is about 5% the size you claim.

    Your 18C aristocrat has a portfolio of shares almost as large as his debt, so his net annual payments to creditors is a tiny fraction of his income from non-financial activities (GDP). That's why they keep lending to him.

    Sorry it's not as exciting as a financial apocalypse, and it doesn't really add much to big-picture arguments about a postindustrial economy or whatnot. But that's accounting for you.

  5. Arlo,

    If the 18C aristocrat had a load of shares he could cash in, why would he borrow money at interest? Wouldn't he use up his cash first?

    With regards to the UK, what happens if the people 'we' have been lending money to cannot repay the loans? Presumably we are still liable for the 12 trillion dollars in debts?


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