Nadeem Walayat
November 28, 2008
The mainstream media is increasingly full of stories of either Britain
going bankrupt or the coming deflation associated with the recession.
Whilst both are now obvious given the economic data and government
actions however what is missing from the headlines is that under the
weight of the exploding public sector debt mountain, deflation will
fast turn towards hyper-inflation as the government literally prints
money in ever more panic measures aimed at turning the economy around.
Many of the readers of
my articles over the last year at Market Oracle will have seen
this trend unfold as sustainable amounts of borrowing exploded into
unsustainable liabilities due to the collapse of the bankrupt banks.
Therefore this article seeks to analyse how Britain has come to
towards an increased risk of bankruptcy and what action can be taken
to avoid a currency collapse that is the consequences of state
bankruptcy.
Britain's Debt Problem Explained
Unfunded
Pension Liabilities
Whilst
private sectors pensions are determined by what the market will pay at
retirement on the basis of the pension fund values and annuity rates,
the tax payer picks up the tab for public sector worker pensions that
receive up to 2/3rds of final salaries. The public sector has no
growing pension fund which means public sector pensions are paid out
of the current contributions with the shortfall made up by the tax
payer, which has resulted in a huge pensions time bomb that is
estimated at a liability of £996 billion and growing, as more public
sector workers retire into longer retirements, so will the gap between
contributions and pension payments widen which will result in a
pensions time bomb exploding that will hit tax payers hard and act as
an annual public sector pensions tax on tax payers.
Public Sector
Net Debt
The official
debt levels as recorded by the Office of National Statistics estimates
how much the country owes. This currently stands at £624 for 2008 up
from £534 at the end of 2007 and projected to rise to £944 billion by
the end of 2010 as the gap widens between government spending and
revenues as the countries GDP contracts, and the revenues from the
booming financial sector evaporate into thin air. The situation has
now been made worse by the £20 billion tax cut.
Northern Rock
Nationalisation
The estimated
exposure at the end of 2007 was £40 billion, however by the end of
2008 this will have risen to £90 billion following the banks
nationalisation and ongoing housing market crash.
Bradford and
Bingley Nationalisation
In September
the government stepped in to nationalize Bradford and Bingley with an
estimated liability of £30 billion that is set to rise as the housing
market deteriorates towards £40 billion.
Bank Capital
Injections
Nationalization is a last resort as it can prove extremely costly,
capital injections are more affordable alternative with to date some
£37 billion of injections from an authorized pool of £50 billion,
however given the extent of losses amongst the UK's big banks the
amount of capital injected into the banks to keep them afloat could
easily rise to above £250 billion by the end of 2010, failing that a
wholesale nationalization program of the banking system would run into
many trillions of extra liabilities.
Loans to
Banks
As the money
markets remain frozen the bank of England has taken over the role as
counter party to the UK banks in the money markets, which makes loans
to the banks as interbank market loans mature and the banks are
increasingly seeking money directly from the Bank of England to fill
this shortfall in short-term funding. This could literally continue
rising to above £1 trillion, depending on how long the credit markets
remain frozen. By the end of 2008, an estimated £300 billion will have
been loaned to the banks and by the end of 2010 this will looks set to
mushroom to £750 billion.
Tax Cuts to
Fight an Election
The
government has started the ball rolling with a £20 billion tax cut
which is 1.5% of GDP, the expectation is that further cuts of probably
£30 billion to follow early next year in advance of a mid 2009 general
election which will bring the total tax cuts to £50 billion and widen
the gap further between spending and revenues. However the government
will more than reverse these tax cuts during 2010 and 2011. The next
tax cuts will probably be a cut in the basic rate or a significant
increase in the tax free allowance, rather than a cut in VAT which is
increasingly seen as ineffective.
Total
Real Debt
The total
debt as illustrated by the below graph shows UK real Public Sector
debt and liabilities rising from £1.5 trillion in 2007 to 2.1 trillion
by the end of this year, 2.8 trillion 2009 end and 3.2 trillion by the
end of 2010.
In
conclusion, whilst the real debt burden looks set to soar to £3
trillion, however things could still get a lot worse if Britain is
forced to nationalise the entire banking system the cost of which
would run in the trillions ! which really would put the economy into a
bankrupt state as total liabilities more than double overnight.
Debt
as a % of GDP
The labour
government eagerly announces that Britain's borrowing is far lower
than other western countries, however as the above illustrates real
liabilities are far higher than that the official public sector net
debt statistics imply. If Britain's balance sheet was in such great
shape then the British Pound would not have crashed by 29% against the
US Dollar or 22% against the Euro. The below graph shows debt based on
Public Sector Net Debt (PSND) and the real debt levels that takes the
above liabilities into account which show that by the end of this year
debt will be at 157% of GDP and expected to grow to 251% of GDP by the
end of 2010 which is made worse both due to increased borrowing and
contracting GDP.
Britain a Big
Version of Iceland?
Iceland is
bankrupt, the Icelandic Krona has collapsed ands remains frozen, and
the economy has ground to a halt under the weight of the estimated
$100 billion of credit crisis debt as a consequence of the collapse of
the countries banks that is far higher than the countries pre-crash
GDP of $14 billion. The country is now reliant on strings attached
loans to be able to function as an economy to enable it to import
goods and services. Whilst Britain is a long way from a similar fate,
however all of the ingredients are there in that Britain has a more or
less bankrupt banking sector, with liabilities far beyond the states
ability to guarantee without a loss of confidence in all UK debt and a
collapse in the currency. I.e. the bailed out RBS alone has
liabilities of £2 trillion, and a asset gap of at least £600 billion,
therefore in a worse case scenario would require a huge amount of
loans and guarantees far beyond the pin-pricks to date seen in the £90
billion to Northern Rock and £40 billion of Bradford and Bingley. The
Bank of England is the lender of last resort so as to prevent bank
runs, however what happens when the BoE is required to lend £5
trillion as a last resort? The answer is currency collapse followed by
hyper inflation.
Sterling
The only
thing that had been keeping sterling afloat were the high interest
rates, with the recent panic cuts of first 0.5% followed in November
by a near unprecedented 1.5%, this brings the UK base rate down to
below the ECB rate of 3.25%, with further cuts in the pipeline that
are expected to take UK interest rates to below 2%. Britain has all of
the problems that the US has such as the large budget and trade
deficits, however sterling at just 4% of the worlds foreign exchange
market is nowhere near that of the worlds reserve currency the US
dollar is the worlds reserve currency and amounts to more than 50% of
the worlds foreign exchange market and as the article
U.S. Dollar
Bull Market Update illustrated, which gives the Americans the
advantage of getting away with borrowing and printing money to an
extent that we in Britain or elsewhere cannot hope to replicate
without experiencing a currency crash. Similarly much of US foreign
banking sector debt is in dollars, whereas much of Britain's financial
sector liabilities are to currencies so that the more sterling falls
the more Britain owes in other currencies especially the dollar.
|
 |
|
|
Hence the
deterioration in the UK's finances has resulted in a crash in
sterling, and the trend is not expected to improve, on the contrary
the expectations are for continuing deterioration in sterling's
fortunes for the duration of the recession. The targets illustrated in
previous analysis still stand in that sterling is projecting down
towards £/$137.50 as a multi decade support level which may give
temporary respite to the sterling bear market. However a break below
£/$137.50 would target parity to the US Dollar, which will mean a 50%
loss in the value of all assets for the duration of the bear market to
parity and likewise 50% rise in the price of dollar imported goods and
services and to a lesser degree from other countries, therefore highly
inflationary.
How Britain
Could Prevent Bankruptcy and Currency Collapse
Tax Cuts - Firstly the tax cuts are a
red herring, they are such a small component of the growing debt
mountain, therefore the tax cuts are political in nature that will
have little lasting effect on either the economy or the total debt
mountain. Though cutting VAT by 2.5% is pretty much a useless exercise
given the discounting that's already taken place amongst retailers,
the £20 billion could have been much better utilised by putting cash
in peoples pockets by raising the tax free allowances.
Public Sector Pensions Liabilities-
The government needs to take urgent action to bring the public sector
pensions inline with the private sector pensions, which effectively
means that the amount of retirement benefits is reduced by 2/3rds as
the current growing liability is unsustainable and will mean a huge
burden on tax payers that will start to be felt in the near future and
is already being factored onto the prospects for the UK economy by
foreign investors.
Budget Surpluses by Cutting Public Spending
- The public sector is unproductive,
it always has been and always will be, for instance for every extra £1
spent on the NHS only results in 10p increase in output. Now that the
productive private sector is contracting fast as the once highly
profitable financial sector goes bankrupt and increasingly takes many
corporations that were barely able to survive along with it in the
meantime the unproductive public sector continues to grow and demand
ever larger resources which is resulting in the large increase in the
budget deficit and hence borrowing, the government needs to be forced
to stick to balancing the budget which means
severe cuts in public spending and increases in taxes so as to
pay down Britain's debt to prevent the country from spiraling into
hyperinflation.
The Bankrupt Banking System -
The banks are sitting on huge undisclosed losses that run to over £1
trillion. Unfortunately the only answer here seems to be for a step by
step systematic nationalization of the banking system, where each bank
is taken over, its debts written off, restructured and quickly
re-privatized in a form where retail banks only operate based on the
amount actually deposited, i.e. the interbank market can no longer be
called upon by any retail banks. The same should apply to other
critical financial institutions such as insurance companies. The
statements by Mervyn King and Alistair Darling of forcing the banks to
lend is naive or foolish or just plain ridiculous, because they cannot
lend because they are virtually all BANKRUPT ! And any capital that
they do have is being closely guarded in an attempt to survive the
Banking Crisis, the last thing the banks want to do is to lend to
corporations that may go bust just as we fall off the economic cliff
into a deep recession.
Saving Initiatives - To enable the banks
to increase the amounts available to lend the government needs to make
saving a far more attractive option than it currently is. This could
be done by greatly expanding the amount that can be saved tax free
which currently stands at £3,600 per annum per person. A more radical
approach would be to index savings against a fall in the currency just
as bonds and savings certificates are available that are indexed
against RPI inflation.
Join the Euro - The last resort for
Britain is for monetary union with Europe. The benefit will be that
the falling currency problem related to the issue of debt and
underwriting of the banking system is diluted as the currency then has
far, far more reserves backing it then that for the British Pound
alone would be left to suffer a currency collapse. This is effectively
what the Irish did when they guaranteed all bank deposits at 100%, for
if they had been outside of the Euro then they would have been on the
fast track to where Iceland is today as no way could Ireland meet such
as liability.
The above
measures would be extremely painful but but with a light at the end of
the tunnel which is far better than the debt fuelled path to
bankruptcy that Britain is now upon where as I have mentioned many
times over the recent months, what lies at the end of the current path
is the Weimar republic that resulted in the total loss of value of the
German currency and savings due to hyper inflation.
Dealing with
the Recession
Giving
consumers a 2.5% price discount (VAT) is a ridiculous way to deal with
the recession. If the government really wants to boost the economy
then it needs to look towards supporting the employers and putting
more cash into peoples pockets, in that it could raise tax free
allowances and increase incentives for employers to take on workers.
However the point of a recession is to get rid of the uncompetitive
froth that has been built up over the 15 years of the consumer boom so
that capital and resources can be deployed more efficiently. However
again we have the problem of the ever growing size of the
uncompetitive public sector that negates many positive aspects of a
recession that ensures stagflation follows deflation.
What can
Savers and Investors Do ?
Speaking for
myself, the only real choice available is to move funds out of
sterling into currencies that are not backed by as much debt both
current and future as a % of GDP and will likely thus appreciate
against a crashing sterling. In the immediate future this means the
dollar, euro and yen, of course each of these economies have their own
debt (foreign debt) problems though not on the scale of Britain's ,
(as mentioned earlier) therefore there is also a need to look beyond
currencies and to seriously contemplate long-term holdings in
commodities, precious metals such as gold and silver, especially given
the recent deleveraging sell off.
Hopefully,
the government and Bank of England is not as clueless as it appears to
have been over the last 6 months and the banking system will be
restructured into a functional working model, and the next government
will cut back on public spending as well as address the public sector
pension's deficit.
Those that
advocate and support the borrowing binge in the mainstream press such
as Anatole Kaletsky and Ambrose
Evans-Pritchard need to take a look at the real value of
their savings, properties and stocks, for they can subtract a further
20 to 30% loss of value over the last 12 months!, and there is more to
come, much more, especially if the government takes the whole of
banking sectors liabilities onto its books as Iceland was forced to
do!
Starting with
the sensible economics, the Chancellor is right to cut taxes and to
spend and borrow through the recession, undeterred by rising deficit
projections and the build-up of public debt. The main reason comes
down to a simple proposition that almost nobody in politics seems to
understand: for every saver there has to be a borrower.
Hysterical claims that Britain is on the brink
of “national bankruptcy”, or that the Government has “run out of
money” or that the pound is going the way of the Icelandic krona may
be a normal part of political banter, but they are absurd. Britain's
public debt-to-GDP ratio, at around 40 per cent, is the lowest among
the G7 advanced economies and if it were to rise to 57 per cent, as
suggested by Treasury projections, this would not present a serious
problem. Nor would it drive up interest rates and inflation, to judge
by the experience of Japan, Italy, France and Germany, all of which
have public debt ratios above 57 per cent. -
Anatole Kaletsky - 27th Nov 08 (Times Online)
With deep embarrassment, I plead guilty to
supporting the Brown-Darling fiscal give-away - though with a clothes
peg clamped on my nose. As the Confederation of British Industry and
many others have warned, we face an epidemic of bankruptcies unless we
tear up the rule book and take immediate counter-action. -
Ambrose Evans-Pritchard - 26th Nov 08 (Telegraph.co.uk)
Conclusion
Britain is
Not bankrupt and not likely to go bankrupt in the immediate future,
however Britain is on the path towards Bankruptcy if it goes on the
projected borrowing spree that lifts real debt to £3.2 trillion and is
forced to take on banking system liabilities of £5 trillion, under
such a situation the country would be bankrupt as the currency would
collapse, and we would not be able to service the debt much of which
would be denominated in foreign currencies given Britain's position in
the global financial system. Though the more probable outcome of
stagflation for many years (low economic growth, high inflation and
interest rates) that erodes the value of domestic debt and savings
would in itself be a bad outcome for Britain. The only real solution
is to limit the growth of real public debt by cutting back on public
spending and bringing public sector pensions inline with the private
sector, both of which will be positive signals to the UK debt market
and banking system.
More on the
prospects for inflation in the imminent publication of the Market
Oracle UK inflation forecast for 2009-2010, to receive this and other
forecasts in your inbox subscribe to our
always free newsletter.
More recent
analysis of Britain's Path Towards Bankruptcy
By Nadeem Walayat
http://www.marketoracle.co.uk
