#33. Iraq and a hard place

A MORE DEMOCRATIC BRITAIN WOULD HANDLE THIS VERY DIFFERENTLY

Today, and unless the House of Commons springs a complete surprise, Britain will join many other countries in committing to military action against Islamic State (IS).

Unlike those other countries, however, Britain will not allow government to take military action unless or until approval has been granted by a Parliamentary vote.

Even then, British forces will be limited to operations in Iraq, and will not be allowed to strike IS in its heartland across the border in Syria. This puts Britain into a ridiculous position.

The naïve might argue that the requirement for a vote proves that Britain is more democratic than her partners. In fact, the opposite is true. It is the effective functioning of democracy in countries like America and France which permits action to be taken by the government alone. That a vote is required in Westminster shows just how undemocratic Britain has now become.

Let’s be clear about how, in a democracy, this should work. The authority to take military action is vested in government, not least because it is simply not practical to vote, stage by stage, on the conduct of a war.

The vital role of Parliament is to review, after the event, the actions of ministers, holding them to account if things go wrong. If Barack Obama’s strategy proves mistaken, Congress won’t hesitate to pass judgment, and a similar process applies in France.

This is how it used to operate in Britain. Indeed, Prime Minister Neville Chamberlain was removed from office in wartime because Parliament judged that the government had bungled the intervention in Norway in 1940. (Ironically, of course, Chamberlain’s successor, Winston Churchill, had been the real architect of the Norwegian operation).

After the 2003 Iraq invasion turned into the disaster that many had predicted from the outset, however, successive governments, and Parliament, dropped the ball. In a functioning democracy, Parliament would have reviewed the Iraq operation and passed judgment on the conduct of ministers and officials, holding individuals responsible if this were deemed appropriate.

Instead, government and Parliament have failed to carry out this responsibility.

More than a decade after the event, the public is still waiting for answers about Iraq. This necessarily creates grave mistrust, and has contributed to the widening of the gulf between governing and governed. This, fundamentally, is why a Parliamentary vote is now required.

It is, of course, hardly surprising that the Labour government chose not to investigate its own conduct, but this duty should have fallen on Parliament, not ministers. That MPs failed to force an investigation shows just how far the House of Commons has become subordinate to the executive. What is more surprising, on the face of it, is that the coalition administration hasn’t sought to hold its predecessors to account.

The unavoidable conclusion has to be that, irrespective of which party is in office, real power is exercised by closed coterie of ministers and officials which has a collective desire to prevent the investigation of their conduct. This conclusion is reinforced by the observation, set out in my previous article, that the governance of Britain suffers from a grave lack of accountability.

They do these things better in more democratic countries.

#32. Deep in the hole, part 2

ARE THERE NO LIMITS TO INCOMPETENCE?

In my previous article, I explained that, whilst Britain’s current account deficit has been lurching into dangerous territory (see chart), no one in authority seems even to have noticed, let alone done anything about it.

Please be in no doubt that the collapse in our financial relationship with the rest of the world is ultra-serious. Current account gaps can be filled only by selling assets or by borrowing from abroad. We don’t, quite frankly, have all that much left to sell, and who in his right mind is going to lend to a country which, already massively indebted, cannot live within its means?

There are three main ways in which markets can communicate their lack of faith. First, they can shift capital out of the country, and this seems to be happening. Second, they can sell off sovereign debt, in our case gilts, which raises the effective cost of borrowing. Third, they can dump Sterling, and under certain circumstances this can force us to raise interest rates.

Capital flight can turn into panic. A weaker pound can hike up the cost of buying essentials such as food and energy. Higher interest rates would be a disaster for a country in debt to the tune of about 500% of GDP. If a big jump in rates was reflected in mortgage costs, the result would be catastrophic.

All of this being so, why does it seem that no-one is watching what’s happening to our current account balance?

Can anyone in a position of authority be quite that stupid?

Well, if the last-ditch effort to bribe the Scots into a “no” vote is anything to go by, they certainly can be.

The flying of the saltire over Downing Street – or should that be Clowning Street? – was ridiculously patronising.

The leaders of all three parties have signed a “vow” promising more powers and money to Scotland, seemingly without even pausing to consider how this might go down in the rest of Britain. (UKIP must be rubbing their hands with glee).

In any case, this (ungrammatical) pledge has little or no substance. On top of this, Cameron, Milliband and Clegg seem to have handed over the “spear point” of their last-ditch panic campaign to Gordon Brown, a man whose premiership was brought to a decisive end by the electorate and who presided, as chancellor, over the biggest borrowing binge in British history.

Can these people be serious? Actually, I think it’s the system at fault, not individual leaders. To be sure, David Cameron has attracted a lot of the blame, but his only real mistake was a refusal to offer some form of “devo max” as a third option on the ballot paper. Ed Milliband clearly fears the loss of a potentially decisive bloc of Labour seats should Scotland leave, whilst Nick Clegg wants to pretend to be the leader of a major party before the Liberal Democrats’ seemingly-inevitable meltdown at the next election.

But it would be naïve in the extreme to blame the whole mess on the three party leaders. Rather, what we have is systemic incompetence. We see this all the way across the public administration, ranging from the tragic (Stafford Hospital) to the appalling (Rotherham) via the simply incompetent (passports, border control, failed IT projects, the rail bidding fiasco – and now, of course, the Scottish referendum).

The system, it seems to me, is not just incompetent but complacent. In few if any of the instances of gross incompetence which have happened in recent years has anyone lost his or her job, let alone their gold-plated pension. In the absence of penalties for failure, incompetence thrives.

If you looked at Britain as an investor would look at a business, you would be struck not just by excessive debt and a severe cash flow shortage but also by managerial ineptitude.

This needs to be sorted out – and soon.

#31. Deep in the hole

WILL STERLING SLUMP AFTER THE SCOTTISH REFERENDUM?

As some of you will know, I last week authored a paper for the Centre for Policy Studies (CPS) highlighting four independence risks – three of them specific to Scotland, and the fourth affecting the residual United Kingdom (“rUK”) in a post-independence situation.

In brief, my paper argues that the “yes” campaign has been over-optimistic about North Sea oil revenues, has underestimated the likely migration of the financial services industry from a post-break-up Scotland, and should also weigh the burden of its share of future public sector pension costs. You can read about this in my CPS report, which is available here for you to download.

The issue that all of us – Scots included – ought to be thinking about now is the fourth, UK-wide risk. That risk concerns our current account position. The current account deficit is more than the simple shortfall in the trade in goods and services. It also includes cash movements related to returns on capital.

In 2013, our trade balance was a deficit of £28.5bn, which may not seem all that shocking. After all, it was a lot worse than that in 2007 (£36.7bn), when buoyant consumers were still sucking in imports, and we’ve haven’t been in the black on overseas trade since 1997.

The recent trend looks pretty static – trade deficits of £23.3bn in 2011, and £33.4bn in 2012, before last year’s £28.5bn.

Broaden this from the simple “trade” imbalance to the “current account”, however, and a much more worrying position emerges. Our deficits in 2011, 2012 and 2013 were £22.5bn, £59.7bn and £72.8bn. It’s the difference between these two lines that is all-important.

In 2011, the £22.5bn current account deficit consisted of a trade gap of £23.3bn offset by a small (£0.8bn) positive cash movement number.

In 2012, a trade gap of £33.4bn was exacerbated by adverse cash movements of £26.7bn.

Last year, the trade deficit was £28.5bn but the cash outflow was £54.9bn, making a total of £72.8bn.

In other words, cash movements have crashed, from near parity to a huge outflow. This is very obvious from the chart included here.

The scary line that markets are going to worry about is the bright red one, showing how our current account has crashed. The dark red line – essentially the sum of interest, dividend and other current remittances – shows why this has happened.

 

Two questions arise. Why has this happened? And what does it mean?

Cash flow has slumped because two line-items have lurched deep into the red. We’re paying out a lot more in interest than we’re getting in, and profits remitted from British-based businesses to their foreign owners now far exceed remittances coming here from British-owned businesses overseas.

What it means is that we’re living on tick. You see, there are really only two ways in which a current account outflow can be reconciled. We can borrow from foreigners, or we can sell assets to overseas buyers.

We’ve been doing both – in spades.

Obviously, the scope for both of these expedients is limited, and both lead to a worsening in the cash balance. Borrow more from foreign lenders this year and you’ll be paying them more interest next. Sell assets this year and more profits are remitted next year.

The time limit is set by our net international investment position – abbreviated NIIP, this really means “how much do foreigners own of us, and how much do we own of them?”
Official statistics put our NIIP at zero. Optimists (including H.M. treasury) think that, because our overseas investments are older than foreign investments here, marking all these investments up to current values would lift our NIIP to perhaps 30% of GDP.

They might even be right – but how long does 30% of GDP last, when the annual outflow is 5.5% of GDP, and seemingly rising inexorably? Not long ago, Robert Peston – one of the very few commentators who seems to have noticed this at all – reckoned that we might go on like this for five more years, but only if we could cut the current account gap from 5.5% of GDP to 4%.

That’s a tough ask anyway – and we’re in vortex territory here, of course, because the more that we borrow this year, and the more that we sell, the more we’ll be paying out next year in interest and profit remittances.

Here’s where Scotland comes into the equation. Take away Scotland’s oil and gas and our current account deficit lurches down from £73bn to at least £100bn, or 7% of GDP compared with 5.5% now.

We can’t put this issue off for long anyway, of course – not least because North Sea production continues to fall sharply – but, if you think about that 7% figure, you’ll realise why Sterling slipped on the merest rumour of a “yes” lead in the polls. If Scotland leaves, then, it’s a fair bet that Sterling will slump.

And here’s my other bet – Sterling will fall even if Scotland votes no.

My thinking here is that the markets have been running their slide-rules over Britain, and they don’t like what they see. Sellers may be holding off until they see the referendum result, with the hope of selling into any temporary strength that might happen if the “no” camp wins.

If I’m right, the capital outflows of recent weeks are not just the consequence of referendum jitters. They owe rather more to devaluation jitters.

$1.50 here we come?

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Please note: due to moving house, my replies here are likely to be delayed over the next few days

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#30. Pensions, oil and finance

WHY SCOTS SHOULD SAY NO TO INDEPENDENCE

Until now, I’ve been hesitant to write about the Scottish independence referendum, though there is no reason whatsoever why the English, the Welsh and the Northern Irish should desist from commenting on a matter that, after all, will affect everyone.

As someone once said, “a country is more an idea than a place”, and I recognise that questions of national identity involve issues which are as much heart as head. Consequently, perusal of statistics cannot alone provide answers, so it is with considerable reluctance that I conclude that going it alone is not an economically attractive option for Scots.

Though I’m not a Scot, I began my working life north of the border, where I found that Scotland is indeed a very different country from England, and in many ways a better one. On grounds not just of history but also of culture and education, the ‘heart’ case for independence is a compelling one. Moreover, I can understand Scots’ aversion to government from Westminster and Whitehall. Indeed, were it on offer I would certainly vote in favour of all four nations securing independence from London!

And yet, and yet. The head, as much as the heart, has to come into the equation, and it is on matters of economics that the case for Scottish independence falls flat on its face.

North Sea oil is a critical part of the equation, yet the heated public debate over this issue has almost entirely missed the point. The focus on remaining recoverable reserves is irrelevant, since whether these reserves are 10 or 20 billion barrels makes very little difference.

What matters is production and, relatedly, the profitability and tax-yielding capability of North Sea oil. Over the ten years from 2003 to 2013, British (for which read “overwhelmingly Scottish”) production of oil declined by 62%, and output fell by almost 9% last year alone. I expect the pace of decline to slacken, but nevertheless to continue, reducing output by a further 30% between now and 2020.

Moreover, the perfectly logical cherry-picking of the past means that remaining oil reserves are becoming increasingly expensive to produce, with some reserves likely to cost as much as US$60/bbl in capital investment alone. If we add in operating expenses, transport costs and the return on up-front capital, it becomes clear that unit profitability is on a severe downwards trend.

The North Sea may continue to produce substantial quantities of oil, then, but its tax-gathering capacity is eroding at annual percentage rates well into double figures.

In short, tax revenue from oil is likely to fall more rapidly than production, probably halving by 2020.

The second issue is Scotland’s income from financial services. The SNP’s glib assumption that an independent Scotland would be invited into the EU as a matter of course ignores the likelihood that Spain, mindful of Catalan ambitions, might veto this precedent. Even if Scotland were admitted, it is likely that she would be compelled to adopt the Euro.

The alternative of piggy-backing on Sterling would be very nearly as bad, since Scotland would be surrendering monetary policy to a foreign country, and would find her room for fiscal manoeuvre very seriously constrained as well.

This combination of monetary considerations suggests that much of Scotland’s financial services industry would “tak’ the low road” to London, stripping Scotland of significant output and revenue just as the North Sea contribution, too, is in sharp decline.

Critical though oil and financial services are, the clincher, for me, has to be public sector pensions.

Unlike private sector provision, which puts money aside to meet future liabilities, the British public sector pension system is a state-sanctioned Ponzi scheme in which the workers of today receive their pensions from the taxpayers of tomorrow. If the government of today were required to put money aside to pay future public sector pensions, the sum required would be of the order of £1,000 billion.

All such Ponzi schemes unravel eventually, and the gap between payments and contributions has already widened alarmingly. This is likely to continue, and the time will certainly come when Britain has to face a painful choice between reducing public sector pensions or hiking general taxation. Unfortunately, this choice is likely to be forced on Scotland much more quickly than it will be imposed on the United Kingdom.

The fiscal cocktail facing an independent Scotland would, or certainly should, daunt the bravest heart. With monetary (and probably fiscal) policy imposed from abroad, with North Sea oil taxes in steep decline and with much of the financial services sector in flight, an independent Scotland might pretty soon find itself unable to meet pension commitments without imposing still more taxation on a shrunken economic base which will already be taxed to the hilt.

As an aside, I do wonder whether public sector workers in Scotland realise the personal risk that a “yes” vote would entail.

More broadly, the choice between “devo max” and full independence looks, perhaps sadly, a pretty straightforward one.