#234. Britain on the brink

THE PRICE OF EXTREMISM

Whether the country’s leaders know it or not, the United Kingdom is now at serious risk of economic collapse.

We must hope that this doesn’t happen. If it does, it will take the form of a sharp fall in the value of Sterling which, in these circumstances, is the indicator to watch.

A currency crash would cause sharp increases, not just in the prices of essential imports such as energy and food, but also in the cost of servicing debt. In defence of its currency, Britain could be forced into rate rises which would bring down its dangerously over-inflated property market.

This risk itself isn’t new. Rather, it results from a long period of folly, and can’t be blamed entirely on the current administration, inept though the Johnson government undoubtedly is. What we’re witnessing now seems to be a government on the edge of panic. The official opposition doesn’t offer a workable alternative programme, and mightn’t be electable if it did.

We need to be clear that the root cause of Britain’s problems is long-term adherence to an increasingly extreme ideology sometimes labelled ‘liberal’.

It’s one thing to recognize the merits of the market economy, but quite another to turn this into a fanaticism which judges everything on its capability of generating short-term private profit.

Extremism is divisive, and creates winners and losers to an extent that moderation does not. If solutions still exist for Britain’s worsening problems – and that’s a very big “if” – there are two reasons why such solutions mightn’t be adopted.

The first is that these solutions would anger a very vocal group of winners under the existing system.

The second is that those in charge would have to make a public admission of the failures of extremism.     

The practical problem

There are two main structural problems in the British economy, both of which are simply stated.

First, the economy operates on the basis of continuous credit expansion.

Even before the onset of the pandemic in 2020, Britain had spent twenty years adding £4 of new debt for each £1 of reported “growth” in GDP. The mathematics get even worse if we add broader financial liabilities, and unfunded pension commitments, to the equation. Where Britain is concerned, these broader liabilities are enormous.

Even this 4:1 ratio understates the grim reality, because the injection of liquidity creates transactional activity – measured as GDP – rather than adding value. SEEDS calculations indicate that, within recorded “growth” of £715bn (at constant 2021 values) between 1999 and 2019, only 30% (£215bn) was organic expansion, with the remaining 70% (£500bn) the cosmetic effect of borrowing at an annual average of 7.2% of GDP through this period.

This process is underpinned by the over-inflation of the values of assets, and principally of property. High and rising property values provide both the collateral and the confidence for perpetual credit expansion.

This is why successive governments have sought to promote, rather than try to tame, house price escalation.

Every initiative branded as “help” for young buyers has, in reality, been a device for propping up or further inflating the real estate market. At the first sign of a wobble in house prices, transaction taxes (stamp duties) are suspended. A property price crash is one of the nightmares that haunts the slumbers of British decision-makers.

It might even be contended, not without justification, that what passes for an “economy” has become, in reality, just an adjunct to an over-inflated property sector.

The second structural weakness is the permanent and worsening current account deficit. The United Kingdom consumes more than it produces. The system incentivizes people to make money – preferably through asset price escalation – rather than to produce goods and services.

A concept which has been described here before is the distinction between globally-marketable output (GMO) and internally-consumed services (ICS). In Britain, GMO has become dangerously small, such that excessive reliance is placed on ICS.

Hitherto, the structural current account gap has been bridged by the sale of assets to overseas investors, a process which has seen major companies, utilities and even football teams sold into foreign ownership.

This trend has become particularly acute since Britain ceased to be a net exporter of oil and gas.

Current account deficits, once embodied in the system and funded by asset sales, have become an autonomously worsening problem, because each asset sold to an overseas buyer sets up a new outflow of returns on capital to the new owners.

Self-created risk

The dangers implicit in this structure are clear.

First, a heavily indebted and credit-dependent economy is extremely vulnerable to rises in interest rates. This vulnerability has become acute now that the global rate cycle has turned upwards.  

As well as increasing the cost of servicing debts, rate rises threaten to crash asset markets, thereby taking away the collateral and confidence props required for the continuous credit expansion upon which the British economy relies.  

Second, overseas investors might start to wonder about Britain’s ability to cope with a steadily worsening structural current account shortfall, reasoning that there are limits to how long any economy can survive by “selling off the family silver” or relying on “the kindness of strangers”.

Additionally, of course, FX markets might fear a descent into chaos. The UK authorities’ approach to inflation looks – to put it charitably – like a product of blind panic.

Problems cannot be fixed by appointing a “tsar” and starting an ad-and-slogan campaign. There’s not much point in urging companies to hold down or even cut their prices when those companies’ own costs are soaring. Workers are unlikely to pay much heed when highly-remunerated officials urge the virtues of wage restraint.

It’s rumoured that, at the same time as increasing state pensions by 10%, the government plans to limit public sector pay increases to as little as 3% or even 2%. If this does indeed turn out to be the plan, chaos can be expected to ensue.

Britain could, of course, adopt what might be called a ‘5-5’ programme, setting 5% as a pay and pensions norm for the current year, with the rider that a further 5% increment will follow in the next year.

Funding this, though, would require major fiscal reforms which, whilst benefiting the young, would anger the (generally older) beneficiaries of the current system.

The clear and present danger now is that markets might decide that the dubious attractions of Sterling are far outweighed by the risks. A “Sterling crisis” would force the Bank of England into raising rates, crashing the property market to which the economy is, increasingly, an adjunct.

A crash in the value of GBP would trigger runaway inflation by increasing the cost of essential imports, including energy and food. Debts denominated in overseas currencies would soar, to a point where Britain could no longer afford to service these debts, let alone repay them.  

The ideology trap

Some, indeed many, of these problems and vulnerabilities are replicated elsewhere.

But what sets Britain apart is its long-standing adherence to an increasingly extreme ‘liberal’ ideology.

We’ve seen this over decades, with a succession of initiatives designed to translate taxpayer funds into private profits.  

Even those of us who favour the market over the state-run economy surely realize that there’s a balance to be struck between private incentive and the role of the public sector, and that any form of economic extremism tends to be both harmful and divisive.   

Taken to extremes, this version of ‘liberalism’ becomes the same system that sent small children up Victorian chimneys. That probably wouldn’t pay in the 2020s, but its modern equivalents – the “gig” economy, “zero-hours contracts” and the relentless undermining of security of employment – have all been warmly welcomed in Westminster and Whitehall.

Extreme liberalism has made the British economy, and British society itself, increasingly dysfunctional. The system is biased in favour of those generally older people who already own assets, and loaded against the generally younger people who aspire to accumulate them. It favours speculation over the creation of value.   

Perhaps the biggest problem of all is the extent to which the public has swallowed the propaganda of liberal extremism, an extremism which states that anything motivated by private profit must be superior to anything managed on the basis of the general good.

The problems of the 1970s are painted, not, as they in fact were, as the consequences of two global oil crises, but as the failures of Left-leaning governments and the malign behaviour of organized labour.

This is the same kind of myopia which remembers the Defeat of the Spanish Armada in 1588, but forgets the Defeat of the English Armada in the following year.

This becomes more pertinent when it is recalled that the debacle of 1589 resulted from efforts to turn a military expedition into a profitable enterprise. Floating a naval campaign as a quoted joint-stock company must have seemed as bizarre at the time as it does now.

If you’re interested in military history, you’ll know that the best of Britain’s trio of wartime heavy bombers were the Avro Lancaster and the Handley Page Halifax.

The danger now is that the name of the third one – the Short Stirling – might sound like an increasingly good idea to international investors.