Bankruptcy beckons for not-so-Great Britain
Plans to save the country from recession could end up capsizing the economy, warns Philip Delves Broughton
How quickly could the United Kingdom go bankrupt? Given the speed at which countries and companies have been brought to their knees in recent months, it is no longer hard to envision a scenario in which foreign investors become spooked by the UK's soaring debts and flee.
The hot money, which has propped up the UK economy for the past decade, will seek safety in Switzerland, Japan and the Middle East. And within days, Regent Street will look like downtown Reykjavik.
The bankruptcy scenario goes like this. British output is already falling, and tax revenues along with it. But the government is not merely holding spending steady, but actually increasing it to fund tax cuts and bank bail-outs.
Suddenly the prospect of a £1tr national debt does not seem so distant
This year the government is expected to borrow at least £70bn to add to the £640bn it already owes its creditors. Throw in the hundreds of billions it has made available in credit to banks, and suddenly the prospect of a £1tr national debt does not seem so distant.
Now, if you were a lender looking at the United Kingdom's credit application, how would you feel? Here is a client who spends around 10 per cent more than he earns every year. His income is now set to fall, while his expenses will rise as he has to support ailing family members and pay a mortgage about to reset to a higher interest rate.
He acquired his main asset, his house, with a 95 per cent mortgage and the house has just fallen 15 per cent in value. The client advises that he is going to solve this blip in his personal finances by running up every available line of credit he can and spending. He is already awash in consumer debt and has the lowest savings rate among his neighbours.
Are you ready to lend? Or more inclined to run screaming from the room?
Meanwhile, every other lender around is running around with his hair on fire, not lending to anyone. And the client is also asking to borrow money in a fast-depreciating currency, so the value of his repayments, if you are a foreign investor, is set to fall. Are you ready to lend? Or more inclined to run screaming from the room?
Evidence that investors are doing the latter can be found in the market for UK gilts, which the Bank of England has been issuing at a record pace this year to fund the government's spending and bank bail-outs. In good times, investors are happy to lend to the British government. Not any more.
Over the past two months, it has been reported, foreign investors have pulled out around three quarters of the money they invested in UK gilts over the past four years. Short-term gilts, which the government must repay within a couple of years, are trading at record high prices, while long-term gilts are at 30-year lows.
What this means is that confidence in the long-term future of the British economy is roughly where it was during James Callaghan's Winter of Discontent in 1978-79. Anyone who does lend, wants to be repaid quickly.
To return to the bankruptcy scenario, Britain now finds itself with a falling currency and low investor confidence. Anyone looking for a reserve currency other than the dollar or yen gravitates to the euro over sterling. Britain has to go the Argentina route and start offering higher interest rates to potential lenders simply to pay its interest bills.
Britain is suddenly unable to pay its bills or roll over its debts. It is bankrupt.
Meanwhile, the cost of crucial imports such as food and manufacturing goods soars owing to the crippled pound. Inflation takes hold. A financially cautious world wants nothing to do with Britain's key export, financial services. Foreign currency inflows stall.
The hedge funds and private equity firms which propped up London's economy either close up shop due to the lack of any credit or move to Geneva, where the crime level is lower and the tax regime more generous. Britain is suddenly unable to pay its bills or roll over its debts. It is bankrupt. The IMF, the EU, the Americans and the Saudis will have to come to the rescue.
How probable is all this? With nothing more than a finger in the air, I'd say 10 per cent and rising.
Posts
