I cannot forecast to you the action of Russia. It is a riddle, wrapped in a mystery, inside an enigma; but perhaps there is a key. That key is Russian national interest.
– Winston Churchill, October 1939.
It is ironic that from a strictly economic point of view, the United Kingdom today appears more akin to the Russia of Joseph Stalin that was described by British statesman Winston Churchill in his memorable quote in 1939. Its economy is in the throes of its greatest financial crisis in over two generations, yet the UK shows unmatchable resolve in trying to crash and burn itself faster and with greater impact than any other political economy appears to be even contemplating.
From the beginning of the current financial crisis in mid-2007, the UK has been in the forefront of disclosing poor performance from its financial institutions, admitting to significant policy errors, and embarking on reckless monetary expansion.
Even forgetting the factors that led the economy into the crisis, it is the combination of factors being put into place today that will ensure that the economy stays down and finally lead to a sovereign bankruptcy; in most likelihood the first one of the Group of Eight countries. Russia brought the number in this select club of so-called leading industrialized nations up to eight when it joined the Group of Seven – the others being the US, Japan, Germany, the UK, France, Italy and Canada.
The UK has a higher chance of busting through its debt financing requirements, and so being rejected by the international financial community, than any other G-8 nation.
The most recent provocation came from the government’s budget announcement for the next fiscal year. London’s Financial Times issued the following report on Friday morning in Asia:
Gilts prices fell for a second day in a row on Thursday amid increasing alarm over the country’s rising debt levels. Investors took fright after the government’s annual Budget on Wednesday revealed borrowing would soar to levels not seen since the second world war, with a debt to gross domestic product ratio rising close to 80% from today’s 50% .
Investors also questioned the credibility of the UK government’s growth forecasts, which are far more optimistic than International Monetary Fund estimates. Benchmark 10-year gilt yields, which have an inverse relationship with prices, have risen about a quarter of a point since Alistair Darling, the UK chancellor, unveiled the annual Budget on Wednesday.
Ten-year gilt yields rose to 3.51% at the London close – up from 3.31% at the market close on Tuesday – as fears have risen that investors may start to sell because they believe the UK economy is likely to deteriorate further. Rising debt levels and a record amount of government bond issuance at ฃ220 billion this financial year – a 50% increase on last year – have also sparked fears the UK could lose its prized triple A credit status.
If this were to happen, it would represent a disaster for the gilts market that needs the top-notch rating to attract international investors and domestic pension funds.
The UK leads the pack in terms of other G-8 countries in many ways. It was among the first to have a failed bank, Northern Rock collapsing just a few weeks after Germany’s IKB Deutsche and Saschen LB in the late summer of 2007 (see Rocking the land of Poppins, Asia Times Online, September 22, 2007) and the first economy to go into an actual recession in this cycle. Its central bank was the first to directly support banks’ interbank borrowings, the country was the first to aggressively cut rates and, lastly, it was the first country to go in for quantitative easing (QE). Interestingly, putting the notion forward that bond investors aren’t all that stupid, the Financial Times continued this morning as follows:
Significantly, 10-year yields are now higher than at any time since the Bank of England announced quantitative easing plans to buy up to ฃ75bn of gilts to increase the money supply and get the economy moving again. Ten-year gilt yields were 3.64% at the London close on March 4 – the day before QE was announced.
With yields rising to close to pre-QE levels, the effectiveness of the Bank’s policy is now being questioned. The Bank has so far bought ฃ38bn in gilts as part of the programme.
It was following the Bank of England’s lead that the US Fed embarked on similar measures to protect its own banking system, and even unveiled its version of quantitative easing recently. As with the UK experience, the US initiatives are also likely to fail.
Taxing the useful, bailing out the useless
In recent articles, I have questioned the wisdom of Keynesian policies being followed by G-8 governments and in particular the notion that spending can be financed by higher taxes on richer people, as is being suggested by both Barack Obama’s America and Gordon Brown’s Britain.
In the United Kingdom, the idea of bailing out “important” sectors of the economy is now so deeply enshrined that one barely needs to talk about job losses than the government quickly comes out with a policy to direct lending.
I made a big deal of the fact that China is directing bank lending into and out of its property market (see China’s unreal estate, Asia Times Online, ), but perhaps given the relatively early stages of development in China today those policy errors can be excused.
In comparison, what is going on with the UK appears downright Marxist. Consider the following:
- The government requires its major banks to highlight their lending to troubled sectors such as commercial property but mainly with a view to showing greater willingness to lend.
- Cutting lines to any industrial activity such as making cars now appears forbidden for the legion of government-controlled banks.
- Banks are expected to show “understanding” in dealing with the problems of excessively leveraged customers.
- Pension funds are being forced to buy and hold greater amounts of UK corporate bonds than at any other point in their history.
Not being composed of complete imbeciles, the UK government also recognizes that its actions will cause significant financial hardship. Additional borrowing that doubles last year’s total will fill the gaping hole of 220 billion pounds (US$323 billion) in this year’s budget. Mind you, this from a country that has already had the ignominy of a failed bond auction, and perhaps a whole lot more to come its way once the rating downgrades are baked into the cake.
How does it choose to counter the costs of bailing out: does it suggest a means of wiping out government waste (if you will pardon the tautology) or does it plan to provide greater incentives for savings? Neither, as it turns out: the government’s magic bullet is to increase the top tax rate in the country from 40% to 50% in a move designed to raise a further 6 billion pounds in taxes (a piffling 3% of the government deficit).
So let me get this right. You are the finance minister of a country where the number of people making a decent disposable income, say over US$100,000 per year, has sharply declined over the past year. You have already spent hundreds of billions on bailing out your sick banks and even sicker industrial companies. Now, facing a deep recession, you choose to further reduce the disposable income of your most productive citizens to drive home a political point?
To paraphrase Churchill, the UK economy is now a disaster, wrapped in a catastrophe inside a calamity. And someone just flushed the key down the proverbial.