Britain doomed, apparently | FT Alphaville

Britain doomed, apparently

A warning to Great Britain from UK-based investment fund Hinde Capital (a hedge fund that specializes in precious metals):

We wish to outline the gravity of the situation in which the UK finds itself, and by assessing how we got here we can begin to offer our solutions both for monetary and political reforms. Unfortunately we are deeply concerned that far from being cynics or purveyors of doom, the very harsh reality is that the UK is caught in an intractable spiral of negative outcomes.

The two-part note (of which we present the first part) is entitled “Eyes Wide Shut“, and offers a bitterly pessimistic view of Britain’s future, concluding that the country is ultimately doomed no matter what it does.

Among the eye-watering , Austrian-inspired, chapters: “An Olympic handover”, “Hitting the Wall”, “Stop go economics”, “A nation divided”, and “Debt servitude”.

You get the drift.

For those who care to be depressed further, we offer some choice extracts:

Debt impotency is no more reflective than the contraction in new consumer lending in the UK. Overleveraged consumers have no more room to borrow and chastened banks recapitalising have no more room to lend. The UK has not begun to experience this occurrence. In fact the ratio of UK debt to GDP has risen significantly and faster than any country in the world (except Japan, by a whisker). Both public debt and UK household debt has increased worryingly in nominal terms. The UK economy is one of the most indebted economies in the world. Measured on society’s total debt to GDP the UK is only eclipsed by Japan. Depending on how you calculate the debt, the UK now has 5 times as much as debt as a year’s worth of national output. McKinsey recently updated its now famous Debt and Deleveraging Report from 2010 and shows how the UK’s economy has actually increased its debt load since the crisis. This is a remarkable figure given all the talk about austerity, public sector wage reductions and cuts in spending. Importantly, most of the UK’s debt sits within the banking system which has raised fears that the UK government (already sitting on 80% debt to GDP) would need to assume those liabilities thus, essentially, like Ireland, go bankrupt overnight.

And some more on the debt problem:

• Total public and private consumer debt is £5 trn or 340% of GDP. Of particular concern is that UK external debt stands at almost 400% of GDP, higher than any periphery country in Europe. While the UK runs a relatively modest current account deficit of 2% of GDP, the gross external debt level is massive, standing at more than 400% of GDP. This is mainly a reflection of the substantial amount of external liabilities of the UK banking system. This amazing figure must be held up against corresponding foreign assets owned by the UK. This yields the net international investment position (NIIP). In a nutshell, the NIIP measures the difference (in notional value) between the stock of assets held by foreigners in the domestic economy and the stock of foreign assets held by domestic companies, households and the government/central bank (FX reserves).

In the UK’s case, this balance stands at just below minus 10% of GDP.

While the UK NIIP is down from the lows in 2006/07 and 2010, 10% is a high number as it creates a structural drag on the current account in the form of a negative income balance. However, this is only in theory and the UK is a good example of having a strong (positive) income balance even in the face a negative NIIP.

The size is less important that the fact that it is positive even in the face of a negative NIIP. This suggests that the return foreigners earn on capital in the UK is substantially less than what UK investors (corporate and private) earn abroad. This could be a result of UK investors being more shrewd and adept than their foreign counterparts, but this is an unlikely explanation.

(Surely that last point is a reflection of Britain’s ability to increasingly raise funding at record low rates? -Ed)

Though, says Hinde Capital, don’t be fooled into thinking that Britain will be able to attract low sovereign borrowing rates forever:

Crucially, this then raises the question of how much longer the UK can offer such low returns on foreigners’ investment in the country even as the total stock of external debt exceeds 400% of total national income. In our opinion, it is the unwinding of this imbalance which will force interest rates up for UK mortgage holders through stress in UK banks’ funding markets, rather than the BoE being forced to raise interest rates.

So, is austerity the answer? Unfortunately no, since we can’t stomach what we’ve had already, and what we need (to make any difference at all) is much, much more:

A much greater proportion of the fiscal consolidation is coming from spending cuts than from tax rises. But let’s say they do implement cuts. What then? The impact of the remaining cuts to the services provided is difficult to predict; they are of a scale that has not been delivered in the UK since at least the Second World War.

On the other hand, these cuts come after the largest sustained period of increases in public service spending since the Second World War. If implemented, the planned cuts would, by 2016−17, take public service spending back to its 2004−05 real-terms level and to its 2000−01 level as a proportion of national income. The UK has never achieved (or needed to) more than two years’ of spending cuts in a row. This time, it needs to undertake seven years in a row. The scale of cuts is perhaps more relevant than the duration of cuts. The UK plans an 11.2% cut to spending on public services. As we know government consumption rose to a 51% share of the economy. Only the Czech Republic and Slovakia undertook and achieved higher cuts. These are not good comparisons as this was post-Communism and these countries were in disarray.

Public spending in truth has risen by 3.4% or £22.6 bn versus 2008-09, and overall public debt to GDP has risen to 84% of GDP, or £413bn. Now although this adheres to form of past crises that public debt rises as the private sector debt falls – we would say politely it is disingenuous to suggest the UK has undertaken any austerity measures.

In conclusion (of the first part at least), Hinde Capital note most fiscal simulations result in a doomed and over-burdened debt-to-GDP scenario no matter what. There is one caveat based around a lower budget deficit being implemented, but according to them, this is unlikely to happen.

Either way, risk is ultimately concentrated around what happens to Britain when its economy growth fails to outpace its borrowing costs — something which we have, of course, seen in multiple eurozone countries the last few years:

As we have seen in the European periphery, once borrowing costs rise to a significant premium above the nominal growth rate of GDP, and once this feeds into a need for austerity which further reduces growth, the game is up. The debt snowball rolls, and depending on the government’s average maturity of debt, we are talking quarters and not years for the endgame to materialize. So far, the UK is not in this situation mainly due to very low interest rates and its long-dated debt maturity profile. Moreover, it is important to note that, cyclically, the nominal growth rate of GDP can exceed borrowing costs for long periods, enabling surpluses to be run.

Yet all scenarios, even those based on baseline growth projections and continuously low borrowing rates, lead to a steady increase in the debt to GDP ratio.

Though, we wonder, is that really such a bad thing? This FT Alphaville reporter, for one, doesn’t believe a rising debt-to-GDP ratio immediately equals doom for a country which is an established currency issuer like the UK, or for one whose debt features prominently in international reserves.

In fact we are considerably more optimistic on most accounts.

That said, we don’t necessarily disagree with Hinde’s gloomy view either.

Our optimism, after all, is based on the idea that those countries that don’t reset their systems through default, will experience money decay regardless — since investors will fight over the last remaining default-free savings vehicles, the only means for protecting principal, and forgo capital by doing so. Either way, savings will be eroded. Either way, presumed wealth will be destroyed, and to the advantage of those who lived “beyond their means”. 

Indeed, which ever way you look at it, all roads seem to lead to “reset”.

A gloomy view indeed.

But we are optimistic. For the first time ever, the system is potentially able to afford reset. We can very possibly afford to default. We can also very possibly afford to experience money and savings decay, since technological efficiencies have led to booming capacity and abundance in society.

And while those trends may be compromised temporarily by default, it’s very unlikely they will retract completely. What’s more, who’s to say that artificial scarcity — imposed by corporates to protect profitability —  didn’t ensure that cash-strapped people who chose to avoid credit in the binge era didn’t end up living “below the system’s cumulative means” as a result?

In Part two, we are told Hinde Capital will explore why “reset” isn’t that bad an idea at all (albeit from an Austrian perspective), and what Britain might hope to expect beyond the tipping point.

For now, though, you can read the first part in its entirety here.

Related links:
Britain isn’t just in very deep trouble. It’s doomed
– FT Alphavile
Beyond scarcity series
– FT Alphaville
The strange case of ‘funding-for-lending’ confusion – FT Alphaville