Saturday, January 10, 2015

UK Economy Is Showing Cracks

British Shoppers Have Been Buying A Lot!
It seems the world continues to have an over-sized image as to the importance of the UK economy because of both its influence in the financial markets and its close ties to America. I also think a bit of an "aura" remains from the years when Britain was an economic powerhouse and the pound sterling was the world reserve currency. Currently the pound makes up around only 4.4% of world wide reserve holdings. I have written several articles about the economy in the UK and consider the country rather uncompetitive for an advanced economy and guilty of importing far more than it exports.  Its inability to pay its way in the world matters, it means they either have to take on more debt or sell their assets to the rest of the world on a large scale and this is getting harder to do.

The pound has been hammered on currency markets as of late making this an opportune time to reassess the strengths and weaknesses of the country going forward. Early last year I reported about a massive amount of money that was being poured into the UK economy. The story placed much of the recent strength from the fact that thousands of Britons were receiving compensation for Payment Protection Insurance (PPI). Most Americans reading about the pickup in Britain's economy never even heard of the PPI. The total paid out until that time had been £13.3bn or about 22 billion American dollars and constituted a huge economic boost to the country of around 65 million people.  This money entered under the radar of many economist giving the impression that the country was undergoing a strong recovery. This false illusion is now beginning to vanish and the momentum from the infusion of cash has begun to ebb.

Figures recently released show the deficit widened to 6% of national income or gross domestic product (GDP), in the three months ending in October. That means the current account deficit has been well above 5% of GDP for 15 months, which is the worst it's been since records were first collected in the early 1950s. Making the situation even more bleak this comes at a time when the UK's total debts (household, business, financial and government) are more-or-less hitting an all time high of around 500% of GDP. It should be noted that it is almost impossible to get the debt burden down when there's a large and negative current account deficit. It is important to remember, for all the talk of a revival in manufacturing, in all reality the UK would be completely sunk without its strong financial sector that bolsters the service sector. Unfortunately, it is not uncommon for the banks and trading companies that comprise this crucial part of the economy to carry a great deal of risk this makes them very vulnerable when the global economy is unstable or debt and loans cannot be repaid.

More important and the real story concerning the gap in the UK and its current account isn't about trade, it is caused by the collapse in what's could be called its "primary income", which is largely the balance between the income the country receives on investments abroad and what is paid out to foreign owners of investments in Britain. For as long as anyone could remember Britain has enjoyed a surplus on its primary income, but in the second quarter of 2012 their primary income balance went into deficit, and that deficit has become progressively worse. In the fourth quarter of 2011, the surplus on net income from investments was 0.7% of GDP, but that went negative, to the tune of 0.2% of GDP, in the second quarter of 2012. And in the third quarter of 2014 the primary income balance was in deficit by 2.8% of GDP. In other words, over three years there has been a dramatic negative swing from surplus to deficit of 3.5% of GDP in the UK"s primary income balance. 

While much of their current economic woes might be blamed on problems in the Euro-zone which have caused investments in the region to yield progressively worse returns. The overall current account deficit with the European Union was up slightly in the most recent quarter meaning for now the worsening must be attributed to a deteriorating trade picture. With the euro-zone locked in a death spiral the UK should harbor no false illusions of help from across the channel. Just the opposite, if anything they should brace for a wave of contagion that might soon sweep over its shores. Just as troubling is that their primary income balance with countries outside the EU went into deficit of $3.4bn from a surplus of $3.6bn. Simply put these investments don't appear to be able to generate a net profit anywhere in the world. As the pound weakens the country will become more competitive and be able to export more, but it will cost more to purchase all those goods that continue to flow into the country making this a no win situation.

The ugly truth is the deficit in goods has continued to increase while the economy was supposed to be "re-balancing" towards manufacturing, only a growing surplus on services has kept the numbers from becoming ugly. There was a $34.29bn surplus on trade in services, up from $31.33bn. Sadly, the deficit in goods trade was a large $47.85bn, up from $45.16bn. The only silver lining is  a recent big increase in the profits of foreign-owned UK companies, from $14.4bn to $19.4bn. This means the UK can fund its huge current deficit by continuing to sell what some see as their crown-jewel companies and other assets to foreigners,but selling off the best assets of the country is not a fix or long-term solution to their financial woes.

While currently considered relatively stable at some point the indebtedness of the UK will reach a level where foreign investors will question its ability to service or repay its debt. This is especially true if there is not a huge unexpected revival in UK productivity, or the efficiency of workers and businesses. At that point, foreigners would not wish to hold sterling causing the pound to plummet and bringing on a rout in the sterling. This would be similar to what happened in September of 1992 during what has become known as the infamous Black Wednesday crisis. So although it is extremely fashionable, especially in the the financial sectors of London to simply ignore the growing record current account deficit it has become a cancer eating away at the future of Britain. At some point this will all come back to haunt the UK and they will rue the fact they have continued consuming more than they can afford.

Footnote; Please feel free to explore the blog archives and as always your comments are encouraged. This article ties together several post I have made over the last few months. More in the article below concerning the PPT and how for a time it gave the illusion the UK was on the mend.


  1. Although PPI now seems to have run its course, stimulus by other means continues in the absence of QE. The banks are now paying out on some piece of crap that they sold their customers called "identity theft" insurance. I managed to retrieve £450 back for my wife. As in America student loans are an increasingly popular method of bringing money into the economy. For the poor student though once you have taken their money its virtually impossible to avoid having to pay it back. On top of this, the FT has pointed out ,that upon graduation, they only have a 50% chance of landing a job appropriate to their level of education and the salary often does not seem to justify the outlay in obtaining it. You could also mention a few "off balance sheet" items too. I think at the moment the civil service pension, and for what passes as social security here (the latter being the biggest item of state expenditure) liabilities run in excess of 300% of GDP. Its not a question of "if" but "when" the UK defaults on its debts. It will be interesting to see who goes first us or the Japs.

  2. Another thing .... One of the most curious of our "exports" at the minute is the construction of flats for sale to foreigners who want to bring their capital to the UK or what ever reason. They range from the infamous One Hyde Park Corner
    to really grotty stuff for the less well heeled `Far Eastern investor. I hope they realise they are buying into what could become Europe's answer to Buenos Aires.