Thursday, November 17, 2011

UK: The Coming Crisis

I have been given a fascinating link from a regular commentator, 'Death to Bubble Addicts' (many thanks!), which is Dr. Tim Morgan's (of Tullett Prebon - TB) report called 'Thinking the Unthinkable: Might there be no way out for Britain'. The link was in a comment on my last post titled 'Austerity of Luxury', in which I argued that there is a disconnect between resources available to government and the extent of government. The post was discussing the disconnect in general, but the Tullett Prebon (TB) report looks at the same issues that I discussed in painful detail for the UK economy. Interestingly, the report mirrors much of the argument of this blog, including a discussion of some of the foundations of the UK's problems, that I discussed in an essay called 'A Funny View of Wealth' in 2007, and which I first published in the blog in 2008.

When writing 'A Funny View of Wealth', I looked for an explanation of the miracle of growth in the UK economy during the 'boom years', looking at figures for manufacturing, commodities, tourism and other sectors such as financial services. In each case, I found that there was nothing which might have explained why the UK economy had been growing so fast, and how it was that the UK was apparently so wealthy. What I did find, however, was growth in debt, and identified that the source of the debt was borrowing from overseas. The only explanation I could see for the apparent 'wealth' of the UK economy was that we were borrowing ourselves into economic oblivion, borrowing for consumption, not for investment. I recommend that you read the essay (it is a bit long), as it is still as relevant today as when I first wrote it.

I recount this argument, as the TB report has done a great job of putting together some figures and charts to make the same point:
All Figures from Page 49

They do not include some of the sectors that I originally looked at, but the picture is nevertheless pretty clear. What we can see is a graphic illustration of what a debt bubble looks like. Perhaps the most important point in the TB report is that they have understood that the massive accumulation of debt during the so-called boom has had a profound effect on the structure of the UK's economy. Mirroring one of my long standing arguments, the report recognises that the UK is not just faced with paying down the mountain of debt, but must do so as large parts of the economy that were sustained by debt-fuelled consumption shrink back.

TB recognise the downwards spiral, where reduction in debt accumulation sees the shrinkage of sectors of the economy, with the knock on effects for unemployment, for tax revenue and for GDP figures. They quite rightly recognise that, even as the government cuts, the shrinkage in the economy will lead to the concern of lenders, as it becomes apparent that the UK economy is much less productive than they thought.The lenders, taking fright at the parlous state of the economy either refuse to lend of do so at a cost that will further accelerate the downwards spiral, with higher interest payments levering the economy downwards.

TB are confronting the problem that, with the debt fuelled sectors of the economy in retreat, it is difficult to see where the replacement growth in the economy might come from. There is a fundamental belief that economic growth will simply turn up from somewhere. However, as they correctly point out, it is apparent that there is no obvious sector which will provide the growth. With much of the economy structured around debt consumption, and shrinking back, where exactly will the growth come from??? With major trading partners such as the EU in crisis and also going through severe problems, it seems that there is no prospect of export led growth. Furthermore, the evidence from the devaluation of sterling over the last few years is indicative that export led growth is improbable.

What I like most about the report is that they recognise the sense of entitlement; the belief that the UK should be wealthy regardless of the actual circumstances of what the UK economy does. They recognise that there is a culture of entitlement that pervades both individuals and government, and that this explains the 'something will turn up' attitude to the current crisis. With wealth as an entitlement, then something will turn up, and economic growth will happen as if by magic. How could it not happen?

And here is the crunch. The TB report accepts that the UK has been 'kicking the can down the road', but also that this approach has about run its course. It is a situation in which the UK is about to be confronted, finally, with the storm that was brewed during the bubble years. They accept that there is no policy that can turn back the storm; the only question is to what will finally provoke the denouement. Recognising that there is no turning away from the storm, they argue that the answer for the UK is to make structural reforms to the economy to pave the way for future growth. Again, all this mirrors the arguments of this blog. However, again in line with this blog, they see the entrenched interests that will work against this kind of reform, as different sectors of society seek to retain their particular privileges and benefits. Their answer is to confront the UK population with the severity of the situation, and try to combine this with an agenda for liberty.

On this last point, whilst I am sympathetic with their aims, I have some measure of doubt as to whether this will work. However, bearing in mind that the crisis facing the UK cannot be turned back, any straw to clutch must be of some benefit. My only other worry with the report is that, although agreeing with many of the points, the report sometimes reads as highly partisan. I agree that the past Labour government were foolish, and can understand the anger that implicitly lurks in the report. However, as I try to do in this blog (not always successfully), it is better to be more studiously neutral; let the situation speak for itself.

Notwithstanding the quibbles at the end, I would strongly recommend that readers take a look at the TB report. At first glance it looks very long, but a large amount of the report is devoted to graphics, so it is relatively quick read. TB are a significant player in the financial system, and it is fascinating to see that many of the arguments of this blog, in particular with reference to the UK, are being considered in such a high profile organisation. The unfortunate part is that they confirm my own understanding of the situation, and sometimes you hope that time will prove you wrong.

Note Added Shortly After the Main Post:

I nearly forgot to mention - one of the comments on the post on Austerity versus Luxury made the following comment:

"There is absolutely no justification for government borrowing in principle. As I have argued, government borrowing is fundamentally problematic. "
What, none? That might make sense over the course of an economic cycle, but surely it's valuable to have in-built stabilisers within the cycle - cyclical surpluses to stop the economy growing too fast and cyclical deficits to mitigate recessions. It's not borrowing per se that has wrecked the West, but structural borrowing throughout successive cycles.
The anonymous commentator quotes one of my key quotes from the post at the start. It is good to see that the commentator agrees in principle with the argument put forward in the post. However,  the comment makes the assumption that government is incapable of actually saving money during the economic cycle in preparation for a downturn. This kind of thinking is an example of the kind of inertia that I mentioned in the post. Governments do not save money, they borrow money. Why? Why can a government not save money for a rainy day, just as individuals do?

I must emphasise that this is in no way a critique of the comment. This was a very useful comment, as it prompted me to ask the question about the assumption. As such, I am very grateful for the comment. In light of the current situation, the focus of the post was, focused upon no borrowing. Going forwards, in the astounding event that government borrowing is one day completely paid down, this is the simple solution to cyclicality. If we can reasonably expect downturns, it seems reasonable to save to ameliorate the negative consequences of the expected downturns.


  1. "Why can a government not save money for a rainy day, just as individuals do?"

    Because Britain/US/Ireland etc has a form of democracy, where the government's first job is get re-elected, and to do this they need to bribe large swathes of the community.

    How could any centre-left/-right party have resisted massive borrowing during the 00's while real-seeming 'booms' were being enjoyed in every comparable country.

    No-one could have sold that idea.

    The media/city/lobbyists/public would not have stood it and any sensible government would have been slung out on it's ear.

    Only places like Scandinavia (where I live) could resist the boom, and this is because they culturally more cautious and interested in fairness.

  2. Given that "the crisis facing the UK cannot be turned back" would anyone like to make a prediction of just when the SHTF moment will arrive?

    Now my understanding is that at some point, we simply won't be able to borrow any more money as a Government and at that point proper 25-30% cuts will need to be applied in a very short time frame.

    As things stand, with all the vested interests and the sense of entitlement I can only imagine a whole scale general strike, riots, etc much along the lines of Greece.

    However, it seems that we are still many years away from the day of reckoning - I'm expecting 'normality' to exist for at least another 5 years.

    We've had the 'credit crunch' but nothing much has changed in terms of day to day life, so just when will the life changing moment arrive?

  3. Yorkie:

    The report implies the UK govt has 12 months from the date the report was written (May 2011) to demonstrate the spending cuts and GDP growth can both be implemented so as to reduce the fiscal defecit.

    They say the markets are giving them the benefit of the doubt that devaluing can stimulate growth.

  4. Yorkie: Apologies, the report was in fact produced in July 2011, so TB give the UK up to eight months before reality bites.

    CE: the similarity between your views and Tim's are uncanny: in the TB Strategy Notes Issue 26 he even has a section titled "Economic Foundations - Smoke and Mirrors". Isn't this very similar to the title of one of your old posts!?

    IMO one of your greatest contributions is the concept of GDP as a failed economic indicator. I would be extremely interested in knowing what your alternative is (forgive me if you have already discussed this).

    It seems to me that in an era of hyper-competition the concept of growth is no longer relevant and it would be better to shift the focus to 'economic efficiency', where economies are measured according to the relative efficiency with which they utilize inputs for production. Is such a concept both possible and desirable?


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