I was finally compelled to post again when I saw an article in the Times. The article deals with storm clouds gathering over UK government funding. For readers from the US, this may deal with the UK, but is just as relevant for the US. I have argued previously that the fall of the UK government into bankruptcy will be the trigger for the loss of confidence in the US. I believe that the collapse of another major Western economy, will finally puncture the illusion of the wealth of the West. I will quote the article at some length:
'Growing concerns in global markets over how Britain will fund the surge in government borrowing triggered by the recession are piling more pressure on the weak pound.'And,
Worries are surfacing over the threat of a vicious downward spiral in which waning appetite among overseas investors for UK assets, including government bonds, or gilts, saps the pound's strength. That, in turn, makes it still less attractive to take further holdings in assets denominated in a depreciating currency.
As well as aggravating the plunge in the pound, the trends could add to problems for the Treasury in raising the tens of billions of extra borrowing needed in coming years as the cost of recession and bailing out banks send the Government deep into the red.
Although these outflows may be fuelled by fretful investors simply bringing funds home, Simon Derrick, Bank of New York Mellon's head of currency research, said that the data pointed to a fundamental shift, and heightened wariness over both UK investments and the pound.
However, he sounds a warning that a global glut of cheap capital that made it easy for the Government to borrow until now is drying up, while Britain will have to compete for funding with governments that are also planning to borrow much more.I have, for a long time, been pointing out that the UK is structurally bankrupt. Back in July I wrote the following:
As I have mentioned, government will need to either borrow more, which will destroy confidence in the UK economy, or will require massive cuts in state spending. If it is the former, then the result will be destruction of confidence in the UK government's ability to manage the finances of the UK and the UK economy. If it is the latter, then there will be a strong downward lever on the economy (at least in the short to medium term).
I have been giving this some thought, and I am coming to a conclusion that it is going to become increasingly difficult for the government to borrow at all. I have detailed elsewhere that the £GB will continue to fall in value. I have argued that depression is looming. The government deficit it going to balloon. This makes lending to the UK government a very, very high risk venture.
My question is this; Will anyone want to continue to lend to the UK government under such circumstances?
I think that the answer, in the coming months, will be 'no'. I am not sure at what point this will occur, but I would guess that the turning point will come in the next six months or so. It is at this point that the government will really fall to pieces. The reason will be that, in the near future, the UK will be calling on the International Monetary Fund. Quite simply, with the huge risks in the UK economy, I simply do not believe that it is creditworthy, and others are going to come to the same conclusion.
As a note, since that post, I have pointed out that the IMF may not be an option, on the basis of the question; who will be funding the IMF?
As the government sought to 'fix' the crisis through the banking bailout, and then chose to spend its way out of recession, it became ever more apparent that the overseas investors, who have been financing the defecit, would gag on such proligacy. I explained the nature of the problem in a previous post at the start of September, and will also quote this at some length:
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.
Once again, it appears that I am in the unhappy position of being correct. I say unhappy, because I still keep hoping that I will be proven wrong. However, the likelihood of that happening appears to be diminishing. The recent news that the government is seeking to stimulate the economy with tax cuts (or buy off voters?) is just another nail in the coffin of government financing.
In another post I identified that one of the major car manufacturers in the US woul fall, making the following post:
The first is that the bailout is just a continuation of the delusion that the UK and US can continue to borrow their way out of economic reality. The other posts are just a series of illustrations that economic reality will have its way (sorry, I am giving an abstraction intentionality here, but you will know what I mean). The service economy is collapsing, and it will take with it large swathes of the US and UK economy with it. As just one example, it is likely that we will see the collapse of at least one of the major US car manufacturers. The US manufacturers have, even during the good times, been struggling for survival, and now that times are tough, they will be in real trouble. The first reports of serious drops in their sales have started.
I pick on the car industry for good reason. In particular I am thinking of Ford, as this is not just another company, but is symbolic of the past successes of the US economy. It might even be argued that Henry Ford invented the modern world of manufacturing. I highlight this, as the failure of a company like Ford will finally create the shock that will really snap the minds of people in the West into the reality of how bad the situation actually is. It is also an illustration of all that is wrong in the Western economies. Ford, and the other US car manufacturers, have been trying to survive with both hands tied behind their backs. I forget the actual figures, but the US car companies have to load into their cost structure something like $1300 (it may be more, I do not have the Economist article to hand) per car, to pay out on pensions, health care etc. There have been numerous negotiations with unions to try to deal with these problems, numerous compromises. However, the unions have never really accepted the severity of the competition that the companies were facing. In the back of their minds was the belief that the companies could not really fail, they were too big and had been there so long...
The idea that the big companies were in trouble was not something that other commentators were unaware of. At present, General Motors is looking ever more at risk, and the response of Barack Obama has been to back a bailout of the industry:
Nancy Pelosi, the Democrat Speaker of the House of Representatives, and Harry Reid, the Senate Majority Leader, are believed to have sent a letter to Mr Paulson asking him to offer a financial lifeline to General Motors, Ford and Chrysler.
It is believed that Mr Obama is supportive of their request, but it is also understood that he is drawing up his own plans to provide federal assistance to help the American car industry to survive.
This returns to one of my long standing themes. Is it possible for government spending and borrowing to support all of the carnage taking place in the economies of the UK and US. Why the car industry, and not the 'little guy' whose business building house extensions is collapsing? More to the point, in bailing out these failing industries, which by definition are bad businesses, the US government is taking on debt, and that debt will be paid for by the good businesses or consumers. In the case of consumers, it adds a structural cost to doing business, as the higher tax required of consumers will mean that paying a 'living wage' will become more expensive for employers.
Above all, this points to the ongoing foolishness; the belief that the UK and US can just keep on borrowing money forever. In a previous post I discussed who I thought would be the best choice of president, and remained neutral whilst advising that the best choice would be the candidate that who was most likely to face reality. It is apparent that Obama has failed already, as much as that might hurt the feelings of those that saw him as a messianic saviour.
As I have long and consistently argued, the way out of debt is not to load up on more debt, but to cut costs in the economy, and prepare the economy for a return to real wealth generation. In the UK and the US the opposite is happening, and the policies of both countries represent pressing down on the accelerator of debt that will take their governments faster over the cliff of bankruptcy.
Quite simply, it is a tragedy.
Note 1: On a related note, I also predicted back in July (when 'experts' were still predicting $200 per barrel) that within two years oil prices would be back down as low as $60 per barrel. Some time after that I revised my prediction down a little lower to $50 (if I remember correctly). Oil futures are now trading at just under $60 per barrel.
Note 2: Sorry not to respond to the many (very interesting) comments and questions, but time really is short today.