After UK lost top AAA credit rating
for the first time in 35 years:
What next?
Comment (Essay)
I just hope that the
disappointment of last week’s Eastleigh by-election result does not discourage
Prime Minister Cameron or Chancellor Osborne away from the part of economic
prudence on which they have led this Country for the past 2½ years. I wrote a blog on the 25th of
January in response to the Deputy Prime Minister’s regret that: ‘The coalition
made a mistake in cutting back capital spending when it came into
office’. In that blog I defended the
government’s austerity cuts as their only wise recourse judging from the
constraints it faced, and that had it embarked on an unfunded mass capital
expenditure programme, it would have lost its credit rating 2 years ago.
Coincidentally, on the day
the UK was downgraded, Lena Komileva, an economist at G+ Economics echoed a
similar view when she told the BBC that: “The very fact that we didn't see this
downgrade happen in the past few years is a testament to the UK's credibility;
there are no magic fixes for this kind of problem. It's not a question of what
the government is willing to do; it is what it can do."
If any good came from this
credit downgrade, it is its effect to serve as a wake-up call to everyone and a
reminder that the UK is not immune from the same problems that the Greeks, the
Portuguese and even the Spanish face.
Yes, the Banking collapse of 2007/08 was the major cause of the economic
problems presently afflicting Western Europe and America, but it is by no means
the only cause; the rise of new competitors like China, India, Brazil and even
Russia is a second factor; no wonder Ben Bernanke, the current US federal
reserve President, said last year that ‘China is hurting’.
A third factor which though
on the surface looks remote, but is in fact an off-shoot of the China-factor,
is the rise of what we could call resource
nationalism amongst less developed economies of Africa, Asia and South America. It is against this background of a world that
is changing in a very fundamental way that we should examine the new awakening
which this credit downgrade has imposed on our thinking.
What are the prospects for
the UK economy in say the next 2, 5 and 10 years; that is in the short, medium
and long term respectively?
Specifically, what will be the position of the European integration in
five years time, and against that background what will be the position of the
Pound Sterling? If the claims by Jose
Manuel Barroso, the president of the European Commission last December that the
EU has now passed its most troubling period is true, and the uncertainty
arising from last week’s Italian election are resolved and the Eurozone march
forward and wax stronger; what effect will such a state of affairs have on
Britain’s fortunes; if we are outside the EU?
Personally, I share the
fears, and reservations of those who think that the EU is more and more
straying away from its core founding objective of promoting free trade into
becoming a political super-State. But
staying away is not the answer, Britain should stay there and rough it out; if it is good enough for
France, a country which has similar historical past in terms of having old
colonies, then it should be good enough for us.
The report by Moody’s
agreed that Britain’s economy is not under any immediate danger, but also
recognised that with a very high Debt to GDP ratio and a stubbornly high annual
budget deficit; if there is no evidence of growth in the overall economy for a
prolonged period, then UK bonds should be rated in a way that reflect that
position; hence they downgraded it from AAA to AA1.
So what is the position of
the UK economy? But before going into
that let us consider the vexing question of growth in the economy which has
acquired prominent headlines in recent years in the media and among politicians, especially the way Ed
Balls, the Shadow Chancellor has predicated his entire economic mantra on
achieving growth by all means and at any cost.
Even the in-coming governor of the Bank of England, Mark Carney has
indicated that he is prepared to ditch inflation targets in order to achieve
economic growth.
Figures released last month
showed a fall of 0.03% in economic activity in the UK, that is GDP, in the last
quarter of 2012. Growth in the economy
is a good thing to which all countries aspire. It is analogous to a workman who
gets good increases to his wages every year, against that he could acquire more
financial commitments and hope to pay for them from his wage rises.
If on the other hand his
wages suddenly stops rising, or worse still, he gets a wage cut he may find it
hard to pay all his additional commitments.
Similarly, if a country’s economy stops growing or even starts
contracting, that is a fall in GDP, then the fear will arise as to whether it
will still be able to meet its commitments as they fall due - This is what
credit rating agencies like Moody’s and others measure.
Economic growth borne out
of hard work; where goods and services are paid for by actual earned income and
where exports are increasing is the Holy Grail which all Nations aspire
to. But a so called increase in GDP
created largely by a frenzied expansion in consumption and paid for by
excessive borrowings is like a house of cards.
It took 300 years, from
towards the end of the 17th century to 1996 for UK domestic
borrowings to reach £ ½ trillion, and just 10 years from 1996 to 2006 to borrow
another £ ½ trillion, bringing the total to £1 trillion then; today it has
risen to around £1.2 trillion. This is
just borrowings by households alone. So
the inflated GDP figures of those years were largely fuelled by a consumer
binge which is largely illusory. Now
that household borrowings are falling, or rather adjusting to reduced Bank
lending the new GDP figures is nearer to reality - But the shadow chancellor
may disagree.
Another factor is the
reluctance among big corporations in Europe, America and even Japan to make
major new investment decisions hence building up cash mountains that run into
several trillion dollars. Dead money, as
Mark Carney calls it, is reducing economic activity which results in reduced
GDP figures. He contends that instead of
sitting on unused cash piles, companies should in addition to increasing
dividend distributions, return cash to shareholder which will in turn find its
way back to the economy.
This is exactly what Apple
did when it decided last year to return a good chunk of its $ ½ trillion cash
pile to investors. Japanese companies’ liquid assets have soared by around
75% since 2007, to $2.8 trillion, according to the ISI Group. American companies have been net suppliers,
instead of users, of funds to the rest of the economy since 2008. Firms in the
S&P 500 held roughly $900 billion of cash at the end of June last year according
to Thomson Reuters; this is 40% up on 2008.
The same trend is found in corporations in UK too.
The Banks are even worse
culprits when it comes to sitting on cash piles, the so called Dead-money
syndrome. The European central bank,
ECB, raised alarm when in just one day last year banks deposited 750 billion
Euros with it overnight instead of lending it to fellow banks. This is exactly what caused the great Banking
collapse of 2007 – 2008 when interbank lending ground to a halt, because banks
started doubting the balance sheets of other banks, they stopped lending to
themselves and instead chose to keep it with central banks for practically zero
returns.
No wonder a few days ago,
the deputy governor of the Bank of England hinted that he may do the
unthinkable and start charging banks interest to keep their money. Think about it, if the banks are now so
reluctant to lend to their own peers, how less eager will they be to lend to
struggling medium and small-scale businesses; that is why the government’s £80
billion funding for lending programme is so far failing to have the desired
result.
The overall burden of debt
on the economy is enormous when you take into account our public, private and
business obligations. They weigh so
heavily on the shoulders of the country that it sort of casts a shadow over
every other thing we do. How much
exactly is our national debt? The
government says it is around £1.1 trillion, but other specialists disagree
vehemently, including even the government’s own official statisticians, the
office of national statistics, ONS.
Adjusted figures from about
one year ago by the City think tank, the Centre for economic and business
research puts the UK’s public debt at more than £2 trillion. But worse still the ONS at about the same
time puts our National debt as high as £4 trillion. In arriving at that figure the ONS added to
the government’s own figures such provisions as it deemed prudent, like: Public
sector pension liabilities, Private finance initiative (PFI) obligations,
substantial liabilities assumed when the State took-over the Royal bank of
Scotland and Lloyd’s bank, and finally £500 billion for contingencies; which
amongst other things, include the various loan-guarantees given by the State.
So, you can now see clearly
that this new government had a mountain to climb right from the first day it
assumed office in 2010. Compounding the
problems posed for this Prime minister by the chronic economic problems he
inherited, is his lack of overall political majority; and having to compromise
with his coalition partners on every front.
As the Lib-Dems more
recently, increasingly re-assert their difference from the Torys, more and more
traditional conservatives are protesting and some are even deserting to UKIP;
this weakens the Prime minister’s grip on his party and consequently on his
government. As I was just typing the
concluding parts of this essay yesterday, the Prime minister was defending his
policy of economic discipline in a speech in a factory in West Yorkshire while
at the same time his business secretary, Vince Cable (A Lib-Dem) was busy
singing from a different Hymn sheet; writing in a newspaper, he implied that
the government should worsen the budget deficit by borrowing yet more money to
fund new capital expenditures.
No, the PM should eschew
populism even if it makes him unpopular electorally in the short run, history
will always vindicate the messenger of a bitter truth in the long run. Even if the Coalition arrangement is forced
into a ‘divorce’ and the Torys become more disunited with the advance of UKIP
that does not mean the end of the political life of this Prime minister.
Just last month Binyamin
Netanyahu of the Kadima party won an increased mandate as the Prime minister of
Israel after the collapse of his coalition arrangement. The Kadima party itself was successfully
created by former Prime minister, Ariel Sharon out of a rebellious Lukid
party. So, you can see that the
political permutations and possibilities open to the PM in future are limitless
if in the judgement of the people he optimised with his acutely limited mandate
when he was in power.
So, after this credit
downgrade; what next for the UK? Terry
Smith, chief executive of Tullett
Prebon and Fundsmith holds the view that
the government should concentrate its effort on reducing UK’s yawning budget
and current account deficits than borrowing more money to pursue an uncertain
growth. He cited the example of Japan,
the world's third largest economy, which has just entered its fifth recession
since 1989 and that its plight is a testament to the poor outcome of applying
Keynesian economic theories, as its government debt is now 20 times
revenues.
Also, Andrew Sentance, a
former member of the Bank of England’s monetary policy committee, MPC, and now
a senior economic adviser at PricewaterhouseCoopers, PwC, is known to favour
similar pragmatism. Again, Professor
Larry Summers, a former economic adviser to President Obama and a Treasury
secretary in the Clinton administration is widely known to argue against
excessive stimulus too. Yes, massive
Keynesian expansion in the 1940s and 50s and 60s by the West went unchallenged
and they were able to sell all their wares; but with the rise of China, markets
are narrowing and you cannot be sure of recovering all your outlay.
I think Britain and the
entire Western economies have to go back to the drawing board and start again
from first principles. What is wrong
with Britain creating a Sovereign wealth fund, SWF, and applying the profits
from such fund towards paying for welfare in the long run rather than
perpetually paying welfare with borrowed money?
Such a fund can be
gradually capitalised over a couple of years with sums cut out from our
bourgeoning Social security and NHS budget which presently gulps about 50% of
the entire annual budget of the country.
China has given out over $1/3 trillion in overseas development loans in
recent years, more than the World Bank and IMF, 75% of which are to developing
nations. There are millions of Chinese
workers in these countries remitting both part of their earnings and taxes back
home plus of course unlimited access to raw materials, re-export of finished
goods and above all taking the trading profits of these enterprises. So it is
clearly a win-win situation for them.
So a completely new
thinking is required; a business-like approach should be used in appropriating
our tax receipts, like investing some of them in a SWF and living off the
profits. This SWF should invest both
locally the UK, in successful companies; like Tesco and Primark and overseas
too. The State should become more
entrepreneurial in other to survive.
2 years ago China acquired
½ of the vast land of Madagascar for plantation farming of maize and palm and
about the same time Indian and Singaporean concerns were investing $4.5 billion
in Garbon, central Africa for similar venture including infrastructure. Nations are now looking further afield; Sir
Terry Leahy, the former head of Tesco said in a Times CEO Summit 6 months
before he left office that Britain should now start thinking globally.
The world should be our
oyster; this is Britain after all, the country that gave the world the English
language. The supremacy of the English
language as the ultimate vehicle for economic and political success in the
world was succinctly articulated in an essay written by Jim O’Neill, the chief
economist of Goldman Sachs on his return from a business trip to China 2 years
ago. In one of the big Chinese cities he
saw a bold inscription on a college signboard which read: ‘Success in English,
success in life’.
I, like Winston Churchill, believe
that the best days of the English-speaking world still lie ahead.
Notice: For the next 3 to 6 months, ‘Weekly Essay’ will regrettably, be
published at irregular times and at irregular intervals. In other words, it will be published only
when available.
Patrick Chike [Editor]
