Recent developments at the Bank of England have provided ammunition to Britain’s considerable community of eurosceptics.
After all, argue some, had the UK been part of the eurozone it could not have quantitatively eased its way out of deflationary trouble. Right?
But there is one unanticipated potential downside to the UK’s QE activities: the prospect of a debt and currency crisis (not to mention those imbalances Mervyn King was referring to on Tuesday night).
Consider the following points raised by alternative research house Variant Perception in a recent report:
- Overseas holders account for almost a third of outstanding government debt.
- Many do not need to hold this debt because they don’t have significant sterling liabilities.
Indeed, at the first chance, foreigners were first in line to sell back their gilt holdings to the Bank of England. The overall effect on overseas holdings as a percentage of gilts outstandings was as follows (chart courtesy of Variant Perception):
Now that might not be so surprising considering the UK’s rather unappealing fiscal outlook — especially from a foreign perspective.
Nevertheless what it did was diminish the immediacy of the QE effect on money supply in the UK. What’s more, it arguably weakened the pound without any intermediary trade-flow benefit.
The specter of as yet un-repatriated sterling sums, meanwhile, still lingers over the BoE’s ability to effectively manage the CPI rate, which could become a problem if and when inflation does begin to creep back into the economy.
Meanwhile, what happens if overseas buyers fail to come back to the gilt market altogether, given the rather impressive issuance schedule? As Variant Perception observed, that wouldn’t bode well for the UK at all:
Only Columbia in 1998 and Finland in 1991 had (marginally) more explosive increases of debt out of the major postwar episodes. Some buyers – like PIMCO – would be further discouraged from owning UK government debt, and others would demand higher compensation to do so, exacerbating the fiscal situation.
And, it adds, (VP’s emphasis):
If the fiscal situation continues to deteriorate there is a non-negligible possibility the UK could face a sudden drying up of capital inflows. A debt crisis would ensue, followed by a currency crisis. This would not be especially unusual for the UK: during the postwar period, there has been one on average every 15 years, like clockwork. Whether this worst case scenario actually materialises or not, gilts and GBP will face a torrid year as investors continue to scrutinize the grave fiscal situation in the UK.
Related links:
Which governments are really at risk of bankruptcy? - FT Alphaville