BRITAIN, EUROPE AND GFC II
A little less than two months ago, we made an effort here to look past the sound and fury of the “Brexit” debate to assess the real state of prosperity and risk in the United Kingdom.
Now, as the world marks the tenth anniversary of the 2008 global financial crisis (GFC I), it’s being reported that Mark Carney, governor of the Bank of England, has warned government that “a chaotic no-deal Brexit could crash house prices and send another financial shock through the economy”.
Risks identified by Mr Carney apparently include a slump in the value of GBP, sharp rises in interest rates and a 35% fall in property prices. Whilst he is right about these risks – and right, too, to warn about the consequences of a mishandled “Brexit” – we need to reiterate that these risks are likely to eventuate anyway, because British prosperity is continuing to deteriorate, whilst financial risk remains highly elevated.
As I’m off travelling for much of next week, what I’d like to do here is to pause, as it were, and posit a few things for thought and comment. “Brexit” risk, and the likelihood of GFC II, have to be high on that list.
First, though, I’d like to thank the first two followers of Surplus Energy Economics who’ve made donations towards the upkeep and development of the project. I’m new to the donation process, so I don’t know what the courtesies are for expressing gratitude – but I really do appreciate your support.
While I’m away, please do carry on posting your comments, but please also note that moderation is going to be intermittent for the next week or so. The best way to get comments posted is to leave out links, as any comment including them is automatically placed in the moderation queue.
Throughout the debate about Britain leaving the European Union, no view has been taken here about the merits and demerits of “Brexit” itself. There are, though, a number of points which do need to be made.
First, the debate about “Brexit” was extraordinarily nasty and divisive.
Second, it’s vital that the expressed view of the voters is respected.
Third, surplus energy analysis gave us a strong lead on how the referendum was likely to turn out. According to SEEDS, per capita prosperity in Britain was already 10% lower by 2016 than it had been at its peak in 2003. This has to have been a major factor motivating the anti-establishment component of the vote.
Finally, “Brexit” is best considered as a ‘situation’ rather than an ‘event’. A ‘situation’ is something which creates a multiplicity of possible outcomes. The biggest risk with “Brexit” has always been that the British and EU negotiating teams would agree (or disagree) to choose the worst possible result. As things stand, that outcome is looking ever more ominously likely, thoroughly justifying Mark Carney’s warnings.
The British predicament
It would be a mistake, though, to assume, either that “Brexit” alone has created these risks, or that an alternative decision by the voters would have taken these threats away. Neither should risk on the EU side be downplayed.
Expressed at constant values, British GDP was £386bn larger in 2017 than it had been back in 2003. This translates to a gain of 11% at the per capita level, after adjustment for the increase (also 11%) in population numbers over that period.
But any suggestion that British citizens are 11% better off now than they were fourteen years ago is obviously bogus, an observation surely self-evident in a range of indicators spanning real incomes, the cost of household essentials, spiralling debt, sharp downturns in customer-facing sectors such as retailing and hospitality, maxed-out consumer credit and the worsening and widening hardship of the millions struggling to make ends meet. The national housing stock might be ‘worth’ £10 trillion, but that number is meaningless when the only potential buyers of that stock are the same people to whom it already belongs.
SEEDS analysis shows how we can reconcile claimed “growth” with evident hardship. First, growth of £386bn (23%) between 2003 and 2017 was accompanied by a 62% (£2 trillion) increase in aggregate debt. Put simply, Britain has been pouring credit into the system at a rate of £5.20 for each £1 of “growth”.
In the short term, you can have pretty much any amount of statistical “growth” in GDP if you’re prepared to pour this much credit into the system. The problem comes when you cannot carry on doing this, and this is especially the case when you’ve also been a huge net seller of assets to overseas investors as part of a process of consuming at levels far in excess of economic output.
Compounding this, of course, has been an escalating trend energy cost of energy (ECoE) and this, in Britain, has soared from 3.4% in 2003 to a projected 9.2% this year. The latter number is close to a level at which increasing prosperity becomes impossible.
“Stalling between two fools”
This makes Mr Carney’s risks all too real. According to SEEDS, aggregate prosperity in the UK last year was £1.45tn, a number 29% below recorded GDP of £2.04tn. When measured against prosperity rather than GDP, the British debt ratio rises to 361% (rather than 258%), whilst financial assets now stand at 1577% of prosperity (compared with about 1130% of GDP).
Bearing these exposure ratios in mind – and noting the ongoing deterioration in per capita prosperity – the likelihood of a currency slump, spiralling interest rates and a severe fall in property prices has to be rated very highly indeed.
But “Brexit” is by no means the only possible catalyst for a crash. Perhaps the single most depressing aspect of the British predicament is the paucity of understanding of, and response to, structural economic weaknesses.
This is not to say, of course, that EU negotiators have played this situation well. The assumption that the EU holds all the high cards in “Brexit” talks is absurd, and the extreme risk to Ireland is just one of many reasons for caution. The guiding principle, which seems to be to punish British voters’ temerity as a warning to others, appears not just pompous but, given the spread of support for insurgent (a.k.a. “populist”) parties, extremely short-sighted.
On the horizon – GFC II
For the British and the Europeans, “Brexit” has been a massive distraction from broader financial and economic risk. Though we cannot know when GFC II will eventuate, there can be very little doubt that a crash, of greater-than-2008 proportions, is looming ever closer.
As regular readers will know, there is a clear narrative which points unequivocally to GFC II. This narrative is so important, and so seemingly absent from mainstream interpretation, that little apology seems required for reiterating it in brief.
The narrative can be expressed as three very simple propositions:
1. From the late 1990s, the secular capability for growth began to erode.
2. Instead of accepting (or even recognising) this deceleration, the authorities embarked on credit adventurism, making debt cheaper, and easier to obtain, than at any previous time in modern history. Not surprisingly, this led directly to GFC I, and ensured that it would be a debt-centred event, primarily threatening the banks.
3. Rather than take the hit for reset, the authorities then moved on to monetary adventurism, pouring huge amounts of ultra-cheap liquidity into the system. This must lead to GFC II, and GFC II must be a monetary event.
There are plenty of things to debate about this sequence. First, what caused the secular deceleration which triggered the whole process? The explanation favoured here is the rising trend in the energy cost of energy (ECoE), but there are certainly some candidates for ‘best supporting actor’. These include ideological commitment to reckless deregulation, badly mishandled globalisation, and the impact of climate change.
Second, why didn’t we choose reset in 2008? With hindsight, the choice made was the wrong one, as many experts pointed out at the time. By playing ‘extend and pretend’, the authorities made huge mistakes, which included moral hazard, creating massive asset bubbles, all but halting creative destruction, and destroying returns on investment (to the particular detriment of pension provision).
One of the lesser-known consequences was that the market economy, properly understood, became inoperable – after all, positive returns on capital are something of a prerequisite in any ‘capitalist’ economy.
Likewise, when the relationship between asset prices and income was bent completely out of shape, immense divisions were created between those who already owned assets and those (generally younger) people whose aim is to accumulate them.
Lastly, is there anything we can do now about GFC II? Frankly, prevention now looks impossible, but there might still be quite a lot of mitigation that we can implement (without going to the extremes of stockpiling tinned food, bottled water and ammunition).
We cannot know whether the coming explosion is going to be ‘chemical’ (requiring a catalyst) or ‘nuclear’ (requiring only critical mass). But there’s plenty of combustible material around, a huge array of potential catalysts – and an inexorable progression towards critical mass.
Abroad thoughts from home
I hope that, despite a short hiatus in moderation and response, readers can carry on debating these and other issues, and will forgive this brief restatement – which to me seems necessary on grounds of imminence and importance – of issues around “Brexit” and GFC II.
It is hoped that, after the intermission, we can get back to pushing the boundaries.
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