Economic Crisis - As Expected Government Finance in Tatters

It has been a while since I last posted, for which I must apologise. I have just been looking through the news, and it is apparent that UK government finance is sinking fast. Regular readers of this blog will know that I have long been predicting a government default, as a result of creditors losing confidence in the UK government, and that I have been tracking the steady erosion of confidence. Even the most optimistic investor will be looking at the latest government figures and will be wondering whether the UK government can sustain payments. In particular, it does not take much imagination to see that the UK economy has not even begun to reach a low point, even if you believe mainstream economists.

In other words, although potential creditors to the government do not yet realise how bad the UK economy will get, they will still realise it has a long way to fall. Perhaps in response to the emerging loss of confidence the government has admitted that taxes will have to rise in the future to pay for the borrowing now, which is a politically painful thing for the government to say, but necessary as a measure to keep creditors on board. The final point of note is that the Yen is strengthening, as the carry trade is now unwinding. It appears that one of the sources of finance in the West is evaporating. For those that are unaware of what the carry trade is, the article explains this, but the important point is that one of the sources of the wall of money that fuelled the credit boom, the service economy and government debt is disappearing. The effect will be less finance available to the West, as well as further downward pressure on Western currencies.

Another piece of news is that inflation is now plummeting, in part on the back of plunging prices in the shops as a result of deep discounting. The result of such discounting appears to be that retail sales have only fallen by a small amount (0.4%), presumably as shoppers think they are being offered bargains. By contrast, retail sales in the US are in a dire state, and it can only be a matter of time before the UK follows suit.

The plunge in inflation was also something that I predicted many months ago, and the I predicted that the driver for the plunge would be the discounting of shops that would be desperate to keep sales in the face of loss of consumer confidence, as well as falling oil prices. Oil prices are now around $50 per barrel, with my original prediction at $60, and a later prediction suggesting that $50 was possible. The fall in oil prices is the best indication of how much trouble there is in the world economy, as the drop in demand for oil is an excellent indicator of the drop in economic activity overall. In my guesstimation for inflation I balanced the factor of retail discounting against the fact that the £GB would be falling, making imports (including oil) more expensive, and concluded that the balance would not be inflationary. It is, however, a fine line, and continued deflationary pressure will in part be determined by how far the £GB falls.

Perhaps one of the interesting points in all of this is that the 'bargains' available in UK shops is probably what is supporting retail sales at the moment. One of the drivers behind my thinking on the UK and Western economies was the experience of living in China. If you are able to speak Chinese, and know China well, it is apparent how overpriced just about everything is in the West. The best illustration of this is the habitual overpricing Westerners are faced with in China, as the Chinese know that they can offer a very high price, and that 'dumb' Western people will still think they are getting a bargain. We are so used to paying outrageous prices for everything, we simply have no idea of how cheap things can be when they go through the supply chain of a low cost economy.

On a completely different subject, I have been watching the saga of the 'Big Three' US motor manufacturers unfold. I found an excellent article on the subject in the New York Times, which I recommend that you read. It is, of itself, an excellent lesson in the importance of manufacturing as the base of real wealth creation. The author looks at the numbers of jobs that would be lost with loss of these manufacturing giants, and it is somewhere in the region of 2.5-3 million. The author quite rightly makes the point that the foreign owned manufacturers within the US would, in part, take up some of the slack, but how much remains a question of debate. The important point here is that the manufacturing industries support a raft of other economic activity throughout the economy.

Whilst many economists have imagined a dreamy scenario in which the West designs and sells products, with high waged workers doing all the design and management, this does not, and never has been anything but a dream. Even were this sunny scenario to be true, how many of this high earning jobs would be needed to support the less well educated workers in productive activity? How many such high paid jobs could ever be supported? The madness of these dreams is part of what has allowed so many to believe that the 'service economy' was sustainable. I have argued before that this was in any case a dream, as the service jobs would anyway follow manufacturing. I gave the example of a product designer. If the designer does not understand the manufacturing processes intimately, then how can they design well. In other words, how will a designer in the West be able to compete with a designer in China, who is cheaper, increasingly as well trained, and has the 'on the ground' experience of the manufacturing processes. As I said, it was always a dream.

The last point is that I have read a commentary in the Telegraph in which they mention that the government is going to 'force' banks to lend. Again, this is much as I predicted would happen, and one of the many reasons why the bailout of the banks is just going to get ever more expensive. What this means is the government is going to force the banks to make very high risk loans, and will sow the seeds for an ongoing bad debt problem for the banks. Any notion that the government will ever make a profit on their banking bailout was always going to meet the problems of political interference in commercial decisions.....

As you may have noticed, there is no particular theme to this post. If I was to pick any theme at all, it is apparent that the dream world that the West has been living in is evaporating before our eyes, but the politicians and public still believe in the dream. With every day that goes by, more news of reality impinges upon their dreams, but still the politicians, and it seems large sections of the public, are turning their faces from reality and comforting themselves with the dream. Even as the UK government pushes the UK economy into destruction, the public appear to be increasingly backing the government in this action. I think that the only thing which will finally shatter the dream is the coming default of the UK government. It is no longer a question of if, but when....

Note 1: A note for Death to Bubble Addicts - Thank you for your invitation, which I will accept when I have time. I have not published your message, as I do not know whether you intended it for publication.

Note 2: I have just found an article on the problems in Ireland. It seems that I may be wrong in thinking that the UK government will be the first to fall into default. It seems that Ireland may be about to reach the finishing post first:

Michael Klawitter, a strategist at Dresdner Kleinwort, said the cost of insuring Irish sovereign debt through credit default swaps (CDS) has surged to 133 basis points. "The markets have begun to see a risk to the solvency of the Irish government. They are questioning whether it has the financial muscle to back up the guarantees," he said.

The problem it seems, is that the Irish guarantee of the Irish banking system is breaking the government's financial position. This is what I have said would happen with the UK bailout (though it is not the only factor, just one of many), but it seems that Ireland is going to be the first to be pulled down. If Ireland does go down, it is a further impetus to the loss of creditor confidence in the UK, and when the UK goes down, the US will follow. Call it economic dominoes if you wish.