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If Britain’s 'other deficit' doesn’t worry policymakers, it certainly should
The UK's current account deficit is the largest in the developed world, with growing worries about how it is financed
Britain lives well beyond its means, importing far more than it exports Photo: AP
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By Jeremy Warner
7:31PM BST 29 Sep 2015
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219 Comments
Most of the news on the British economy right now is good. Unemployment is low and labour participation is at a record high. Growth is back to pre-crisis trend, investment is rising, albeit from exceptionally depressed levels, and with inflation at zero, there has been a welcome return to real wage growth. This has brought with it early signs of a revival in productivity.
Yet there is something which feels not quite right about the nature of the UK’s economic recovery. You don’t have to look far to see the outward manifestation of this unease. Last year, the UK recorded a current account deficit – which is essentially the difference between what the country spends overseas and what it earns - of 6.5 per cent of GDP, the largest peacetime deficit ever, and by far the biggest in the developed world.
Put simply, Britain is living well beyond its means, as indeed it has for a long time now.
There are admittedly a number of reasons for believing the situation is not quite as bad as the headline figures suggest. Despite a still shockingly large deficit in goods, net trade as a whole, boosted by services – where Britain enjoys a substantial surplus - has been on a gently improving trend. The chief cause of the current account deterioration lies elsewhere in a sharp drop in the income Britain enjoys on its overseas assets.
Over the past two decades, the UK has earned considerably more on these assets than it pays on its foreign liabilities. Ben Broadbent, deputy governor of the Bank of England, estimates that this overseas dividend has been enough to pay for a primary deficit of around 2.5pc of GDP a year since the early 1990s, which is quite a bonus.
Unfortunately, that gap has narrowed significantly post the banking crisis, and just recently the balance has gone negative, an unprecedented event. In the low return world we now inhabit, this may, regrettably, have become a permanent state of affairs.
The humungous size of Britain’s overseas balance sheet relative to other advanced economies – substantially the result of growth in its banking sector – makes the UK particularly vulnerable to this loss of income. Worse, on some measures, Britain’s overseas liabilities have in recent years come to exceed its assets, hardbaking the negative balance on income into the ongoing figures.
There are two big conclusions to be drawn from these observations. One, highlighted in a speech by Mr Broadbent last year, is the importance for Britain of maintaining a credible economic policy framework, including inflation targeting and a rules-based approach to fiscal policy.
Without them, foreign confidence in the UK would fast evaporate, and the rates Britain would have to pay for overseas money would go through the roof, further undermining the capital account. A balance of payments and accompanying sterling crisis would soon follow.
Both these things – the inflation target and a credible fiscal strategy - would be in serious jeopardy under Corbynomics. Whatever else you might think of Gordon Brown, he at least understood the risks and took steps to insulate the economy from them. Jeremy Corbyn and his followers appear intent on precisely the reverse. They seem to have no understanding of the knife-edge on which the UK economy is balanced, having either forgotten or deliberately ignored the lessons of the 1970s. Confidence in Britain as a safe place for investment and business has never been more important for the country’s economic health than it is today.
I’ve been much criticised on Twitter for pointing out that the one thing all hyper-inflations have in common – from Weimar to Zimbabwe – is monetary financing of government spending of precisely the type envisaged by “People’s QE”. No, I’m instructed by those who claim to know about these things, it is not money printing as such but institutional breakdown that causes inflation to spiral out of control.
I would only disagree to the extent that few governments would ever try the slippery slope of monetary financing unless the ability to collect taxes and therefore to borrow had indeed broken down.
Again, this is precisely what’s promised by Corbynomics, which fails to recognise the self-evident truth that if you squeeze business and wealth too far, it will simply go somewhere else or otherwise stop growing. Pretty soon a Corbyn government would have no option but to turn to the printing press.
The other conclusion is a more troubling one, for in the general fascination with “the new politics” everyone seems to have forgotten that Mr Corbyn is not the Prime Minister nor ever likely to become so. A credible policy framework is, for the moment, secure, offering some protection against the “sudden stop” of an old-fashioned balance of payments crisis.
Even so, the situation is fragile. External demand is subdued, and threatens to get worse still with the slowdown in China and other emerging markets. The commodities bubble is well and truly over, leaving a worldwide glut of industrial capacity that is likely to depress global investment spending for years to come. The marginal cost of goods, labour and even some services is increasingly set by a stagnant Europe and a slowing China, creating a persistent deflationary downdraft.
To meet inflation, employment and growth objectives, the Bank of England is therefore forced to support domestic demand with a much higher degree of monetary accommodation than otherwise, sucking in imports from abroad and adding to the problem with the current account.
At its last meeting, the Bank of England’s Monetary Policy Committee took some comfort from the fact that this time around, the deficit is financed more by foreign direct investment and portfolio flows than fast money. There are no obvious signs of another credit bubble. This ought to make the economy less vulnerable to a sudden reversal.
Things nevertheless look precarious. The Gulf inflows of recent years are drying up, and unless it is China, it’s not at all obvious what might replace them. Furthermore, solid, if artificially generated, domestic demand in combination with a depressed external environment is bound to be causing some further erosion in competitiveness. Britain’s growth spurt may carry a heavy long-term cost.
The UK's current account deficit is the largest in the developed world, with growing worries about how it is financed
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Britain lives well beyond its means, importing far more than it exports Photo: AP Keep things simple this autumn The minimalist trend is sleek, chic and hot for the season. Here's how to make it work for youSponsored by House of Fraser
By Jeremy Warner
7:31PM BST 29 Sep 2015
Follow
219 Comments Most of the news on the British economy right now is good. Unemployment is low and labour participation is at a record high. Growth is back to pre-crisis trend, investment is rising, albeit from exceptionally depressed levels, and with inflation at zero, there has been a welcome return to real wage growth. This has brought with it early signs of a revival in productivity.
Yet there is something which feels not quite right about the nature of the UK’s economic recovery. You don’t have to look far to see the outward manifestation of this unease. Last year, the UK recorded a current account deficit – which is essentially the difference between what the country spends overseas and what it earns - of 6.5 per cent of GDP, the largest peacetime deficit ever, and by far the biggest in the developed world.
Put simply, Britain is living well beyond its means, as indeed it has for a long time now.
There are admittedly a number of reasons for believing the situation is not quite as bad as the headline figures suggest. Despite a still shockingly large deficit in goods, net trade as a whole, boosted by services – where Britain enjoys a substantial surplus - has been on a gently improving trend. The chief cause of the current account deterioration lies elsewhere in a sharp drop in the income Britain enjoys on its overseas assets.
Over the past two decades, the UK has earned considerably more on these assets than it pays on its foreign liabilities. Ben Broadbent, deputy governor of the Bank of England, estimates that this overseas dividend has been enough to pay for a primary deficit of around 2.5pc of GDP a year since the early 1990s, which is quite a bonus.
Unfortunately, that gap has narrowed significantly post the banking crisis, and just recently the balance has gone negative, an unprecedented event. In the low return world we now inhabit, this may, regrettably, have become a permanent state of affairs.
The humungous size of Britain’s overseas balance sheet relative to other advanced economies – substantially the result of growth in its banking sector – makes the UK particularly vulnerable to this loss of income. Worse, on some measures, Britain’s overseas liabilities have in recent years come to exceed its assets, hardbaking the negative balance on income into the ongoing figures.
There are two big conclusions to be drawn from these observations. One, highlighted in a speech by Mr Broadbent last year, is the importance for Britain of maintaining a credible economic policy framework, including inflation targeting and a rules-based approach to fiscal policy.
Without them, foreign confidence in the UK would fast evaporate, and the rates Britain would have to pay for overseas money would go through the roof, further undermining the capital account. A balance of payments and accompanying sterling crisis would soon follow.
Both these things – the inflation target and a credible fiscal strategy - would be in serious jeopardy under Corbynomics. Whatever else you might think of Gordon Brown, he at least understood the risks and took steps to insulate the economy from them. Jeremy Corbyn and his followers appear intent on precisely the reverse. They seem to have no understanding of the knife-edge on which the UK economy is balanced, having either forgotten or deliberately ignored the lessons of the 1970s. Confidence in Britain as a safe place for investment and business has never been more important for the country’s economic health than it is today.
I’ve been much criticised on Twitter for pointing out that the one thing all hyper-inflations have in common – from Weimar to Zimbabwe – is monetary financing of government spending of precisely the type envisaged by “People’s QE”. No, I’m instructed by those who claim to know about these things, it is not money printing as such but institutional breakdown that causes inflation to spiral out of control.
I would only disagree to the extent that few governments would ever try the slippery slope of monetary financing unless the ability to collect taxes and therefore to borrow had indeed broken down.
Again, this is precisely what’s promised by Corbynomics, which fails to recognise the self-evident truth that if you squeeze business and wealth too far, it will simply go somewhere else or otherwise stop growing. Pretty soon a Corbyn government would have no option but to turn to the printing press.
The other conclusion is a more troubling one, for in the general fascination with “the new politics” everyone seems to have forgotten that Mr Corbyn is not the Prime Minister nor ever likely to become so. A credible policy framework is, for the moment, secure, offering some protection against the “sudden stop” of an old-fashioned balance of payments crisis.
Even so, the situation is fragile. External demand is subdued, and threatens to get worse still with the slowdown in China and other emerging markets. The commodities bubble is well and truly over, leaving a worldwide glut of industrial capacity that is likely to depress global investment spending for years to come. The marginal cost of goods, labour and even some services is increasingly set by a stagnant Europe and a slowing China, creating a persistent deflationary downdraft.
To meet inflation, employment and growth objectives, the Bank of England is therefore forced to support domestic demand with a much higher degree of monetary accommodation than otherwise, sucking in imports from abroad and adding to the problem with the current account.
At its last meeting, the Bank of England’s Monetary Policy Committee took some comfort from the fact that this time around, the deficit is financed more by foreign direct investment and portfolio flows than fast money. There are no obvious signs of another credit bubble. This ought to make the economy less vulnerable to a sudden reversal.
Things nevertheless look precarious. The Gulf inflows of recent years are drying up, and unless it is China, it’s not at all obvious what might replace them. Furthermore, solid, if artificially generated, domestic demand in combination with a depressed external environment is bound to be causing some further erosion in competitiveness. Britain’s growth spurt may carry a heavy long-term cost.
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