18 February 2008

Indicting the UK ---

Indictment One: the UK current account deficit reached 5.7pc of GDP in the third quarter of last year, the worst of any major country in the world, bar Spain. "This is approaching Banana Republic status," said Albert Edwards from Société Générale. "Years of macro-mismanagement have dragged the UK economy to the edge of a precipice. The household sector is borrowing at a cyclically unprecedented 4pc of GDP. Basing economic growth on unsustainable asset price bubbles was always a recipe for disaster," he said.

Indictment Two: we are a budget basket case as well, with a deficit of 3pc of GDP at the top the cycle. We enter slump without a fiscal shield. Even America is doing better. This deficit is beyond the legal limit of the Maastricht Treaty, not that Downing Street cares. Gordon Brown may have to care more about the bond vigilantes and currency traders who have sharper claws.

They may yet force him to raise taxes into a downturn, as Labour's Philip Snowden had to do in 1931, or as Latin America's big spenders have had to do with an IMF gun to their head. A hard landing will have a "catastrophic impact on UK public finances" as tax revenues dry up and dole costs soar, says Capital Economics. "A recession as deep as that in the early 1990s could push borrowing up to £150bn per annum," it said. In the ERM smash-up, Britain swung from a 2pc surplus to an 8pc deficit. That was the result of subcontracting monetary policy to the Bundesbank. This time we have our own bank, bruised though it may be. It can cut interest rates a long way.

Indictment Three: the state share of the economy has risen from 37pc to 45pc in eight years, on OECD figures. We have risen above Germany for the first time since the Schmidt-Callaghan era. Berlin has been trimming as we bloat fatter. So have the Swedes, Danes, Dutch, Belgians, Austrians, Italians, Spanish and Eastern Europeans. It is a matter of political taste whether you think Brown's largesse on doctors, nurses, schools, and roads has been well used, but there is no denying that we are now one of the most socialist/collectivist states in the world.

Indictment Four: household debt has reached 103pc of GDP, pushing the frontiers of irresponsibility into uncharted terrain. The Americans buckled at around 85pc. UK home equity withdrawals have reached £50bn a year. We are spending unrealised paper profits at a rate of 4pc of GDP per annum. Some 58pc of all home loans issued in Britain in 2006 were either sub-prime, buy-to-let, or other forms of "specialist lending". The effective cash and liquid assets ratio of the banks has fallen to zero.

Is it not disturbing that Northern Rock should have collapsed even before the housing market turned, and defaults had begun to soar? What happens now if UK house prices fall 5pc in 2008 as forecast by Merrill Lynch, or indeed further?

The most pernicious effect of this sorry tale is the impression that Britain might be better off in EMU, under the tutelage of the European Central Bank, which has handled the credit crunch with skill. It carried out a pre-emptive "rescue" of the euro-zone banks by showering the system with liquidity and accepting rubbish as collateral, but it had to do so because there is no clear-cut lender of last resort in EMU. It cannot risk a Northern Rock. Who bails out whom? That must never be tested.

Yes, Mervyn King's hair-shirt austerity was quixotic, and ill-judged, but at least he tried to fight moral hazard. Europe capitulated immediately. It did so because EMU is a dysfunctional monetary union, where the Latin and Germanic halves are moving further apart and so are the spreads on sovereign bonds. The gloss will come off Euroland in due course.

In Britain we must rebuild our smashed credibility. We face a decade of grinding debt deflation, like Japan. Thank you Mr Brown.

No comments: