Saturday, December 13, 2008

The Failed State Next Door

Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.
John Stuart Mill
I'm worried about Britain. Our neighbour is at the centre of the global financial storm that is still blowing and may not survive it intact. Admittedly it is a bit rich to be making this observation from Ireland, which managed to go into recession several quarters before everyone else thanks to our property ponzi scheme. Still, I am worried.

A number of UK analysts and commentators have begun to fret about where Gordon Brown is leading their country. A deadly mixture of a toxic financial sector, collapsing currency, exploding budget and underfunded sovereign liabilities may prove beyond the capacities of the UK economy to weather the storm intact. The chart is from an analysis by Standard and Poor's delightfully entitled: In The Long Run, We Are All Debt. It projects the sovereign ratings for the UK and other countries, assuming no change in current fiscal policies. UK debt is projected to be rated 'speculative' by 2035. I know, hardly imminent you might think. But here's the thing, the S&P report was written in 2005 ...

Fast forward to last month's UK budget and things have gotten worse - much, much worse. The recent measures announced in Chancellor Darling's budget are set to ramp the UK's national debt up to 57% of GDP in just a few years, assuming a return to growth in 2010. This extraordinary borrowing binge couldn't come at worse time: recent estimates show that the real level of total UK government debt is closer to 276% of GDP when unfunded pension liabilities are included. A great deal of this comprises an estimated £1 trillion in unfunded public sector pension liabilities.

What are the UK's options? On the debt issue they are brutally limited, as noted by the Institute of Economic Affairs in the report linked to above:
Going forward, if the government acknowledges its true debt level, it will have to behave as any highly indebted person, institution or government does – with extreme prudence and the introduction of austerity measures; it will be forced to cut spending, increase taxes, possibly print money, and almost certainly look to break its pensions promises. While none of these options are at all appetising, the situation will keep on getting worse the longer the government delays paying off or reducing its debt. The options available will decline with time, and those that are left will be increasingly painful.
Easier said than done. But the UK government may have no choice - the rapid depreciation of sterling could play havoc with the UK's abilities to raise funds in international markets. As its sovereign rating threatens to drop from AAA the UK may actually be forced to raise interest rates, or face the prospect of being the next Iceland. And all because a Labour government decided to bailout the City of London ...

Referring to the Mills quote at the head of this post, here's how the brilliant blogger London Banker sees things unfolding:
The extent to which capital has been betrayed in the past quarter century under Bretton Woods II, bank deregulation and the Basle Capital Adequacy Accords is unrivalled in the history of fiat banking. The bankers, lawmakers, regulators and academics who collaborated in the betrayal still hold power, like the well-armed brigands in the fortress, and their continued collaboration to prevent accountability must inevitably discourage honest savers from risking further loss. Even so, it is the savers/peons who hold the ultimate power as they can starve the brigands.

Some day soon savers will revolt at financing further depredations. They will refuse to buy even government securities, gagging at the quantities of issue forced upon them under terms of only negative return. When that final massive bubble bursts, deflation will follow its harsh corrective course and clean out deficit-financed “unproductive works”.
The depredations are well under way in the UK, and our cousins across the water are paying a high price for their government's determination to "apply every available resource to underpinning failure, misallocation and executive excess." We do not have to follow in their footsteps - even if, for economic, geographical, cultural and political reasons we will, unfortunately, be caught up in the vortex of the state failure next door.

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