Britain Facing Major Currency Collapse, Bankruptcy
Update: It has been revealed the UK's citizens face at least a decade of pain to pay off the debts from the banking bailout, according to a treasury minister. Lord Myners spoke candidly about how bad the situation is. And it contradicts what the prime minister Gordon Brown has said, when he called the banking bailout a temporary measure.
More disturbingly, Mervyn King, the head of the Bank of England, has spoken of the need for rule-breaking solutions to cope with the scale of economic damage done by the ten-year debt bubble.
The scale of damage to UK banking has some believing by year's end, the UK will only have two UK-quoted bank shares: HSBC and Standard Chartered. An article in the country's Independent newspaper has reported that all the country's banks are now insolvent: http://www.independent.co.uk/news/business/news/british-banks-are-technically-insolvent-1418229.html
What is unknown at this point is how much Britain's young workers are willing to pay the price for this bailout, facing the prospect of earning a very weak pound, huge taxes and low salaries and benefits, until the overhang of debt is worked off.
The UK government announced a 'blank cheque' bailout of the country's banks yesterday, after its £37 billion bailout in October 2008 had failed to make the banks solvent and start lending again.
The currency then dropped to its lowest point in five years against the US dollar (it has hit a seven year low in trading today). A credit rating agency is considering downgrading the UK because its debts are soaring so quickly. If this happens, it will mean the government will struggle to pay interest payments and convince global markets to buy UK debt.
Jim Rogers, the co-founder of Quantum fund with George Soros, today told Bloomberg News that “I would urge you to sell any sterling you might have. It's finished. I hate to say it, but I would not put any money in the UK.”
The UK's citizens are currently the most indebted per person in human history, even outstripping Americans. The size of the debts are so large, the government is considering printing money to help hyperinflate away the country's debts, using something called 'quantitative easing'. The Bank of England was given permission yesterday to do this.
"The risk now is that people are looking back to the run on the pound in 1931, when Britain came off the gold standard and sterling fell by 31 percent," said Richard Turner of IG Index, the spread-betting company.
The Royal Bank of Scotland (RBS) recorded the biggest annual loss for a UK company in history yesterday, losing £28 billion. Its shares collapsed 70 percent after the announcement. RBS alone is causing serious worries because its assets - at nearly £2trillion, which is bigger than Britain's entire economic output - could all on its own overwhelm the country and its finances. When the other troubled banks are factored in, the UK is facing something even worse than what hit Iceland, when its banks collapsed because the country could not back up its assets. The UK has substantial overseas investments funded through the 'City', London's financial and investment centre.
And Shadow Chancellor George Osborne told MPs: 'The first bail-out of the banks has failed and now they have no option but to attempt a second bail-out - a bail-out whose size we still don't know, whose details remain a mystery and whose ultimate cost to the people of Britain will only be known when this Government has long gone.'
Britain has foreign reserves of under $61bn dollars (£43.7bn), less than Malaysia or Thailand. The foreign liabilities of the UK banks are $4.4 trillion – or twice annual GDP – according to the Bank of England. The mismatch is perilous.
It is why sterling has crashed 10 cents from $1.49 to $1.39 against the dollar in two days. The markets have given their verdict on Gordon Brown's latest effort to "save the world".
The UK is in a worse dilemma than Iceland: the entire western world's valuation of assets is based on the pricing cooked up in London's City. If the UK goes down, or chooses to go bankrupt like Iceland did, it takes the entire global capitalist system with it. The whole paradigm, its valuations, and its concepts. Of course, the UK government can't do that, so the UK will have to take on the whole burden of debt and its citizens will face a future of enormous debts to be paid and a currency dwindling in global purchasing power for a long time, if it hopes to dig its way out of this mess.
And the European Commission has warned in a report yesterday the country will suffer the most in the European Union in the downturn. Output will tumble 2.8 per cent in 2009, more than twice the UK Treasury’s forecasts, it said in the damning report. That compares with a decline of 1.9 per cent across the euro area, the Commission said in its ‘Interim Forecasts’.
Partly as a result, UK government debt will skyrocket to 72 per cent of the economy by next year – or over £1trillion.
Also yesterday, the International Monetary Fund voiced its concerns that the UK will need a major IMF bailout along the lines of its bailout of Iceland in 2008. It felt this is just months away.
To date, the UK has had to borrow more money than it did to reconstruct after World War II to patch up its economy after the collapse of the roaring housing and debt bubble of the past ten years.
Poltically, it is an interesting question: will the UK's citizens consider decades of debt burden a worthwhile trade-off for ten years of a bubble economy and the big party it created?
1) A UK commentator elaborates on the crisis: http://www.telegraph.co.uk/comment/columnists/iainmartin/4295219/Gordon-Brown-brings-Britain-to-the-edge-of-bankruptcy.html
Background on UK economic crisis:
November Sunday 30 2008 (15h50) :
Britain a Big Version of Iceland? Bankrupt Britain Trending Towards Hyper-Inflation?
by Nadeem Walayat
Global Research, November 30, 2008 Market Oracle - 2008-11-28
The mainstream media is increasingly full of stories of either Britain going bankrupt or the coming deflation associated with the recession. Whilst both are now obvious given the economic data and government actions however what is missing from the headlines is that under the weight of the exploding public sector debt mountain, deflation will fast turn towards hyper-inflation as the government literally prints money in ever more panic measures aimed at turning the economy around. Many of the readers of my articles over the last year at Market Oracle will have seen this trend unfold as sustainable amounts of borrowing exploded into unsustainable liabilities due to the collapse of the bankrupt banks. Therefore this article seeks to analyse how Britain has come to towards an increased risk of bankruptcy and what action can be taken to avoid a currency collapse that is the consequences of state bankruptcy.
Britain’s Debt Problem Explained
Unfunded Pension Liabilities
Whilst private sectors pensions are determined by what the market will pay at retirement on the basis of the pension fund values and annuity rates, the tax payer picks up the tab for public sector worker pensions that receive up to 2/3rds of final salaries. The public sector has no growing pension fund which means public sector pensions are paid out of the current contributions with the shortfall made up by the tax payer, which has resulted in a huge pensions time bomb that is estimated at a liability of £996 billion and growing, as more public sector workers retire into longer retirements, so will the gap between contributions and pension payments widen which will result in a pensions time bomb exploding that will hit tax payers hard and act as an annual public sector pensions tax on tax payers.
Public Sector Net Debt
The official debt levels as recorded by the Office of National Statistics estimates how much the country owes. This currently stands at £624 for 2008 up from £534 at the end of 2007 and projected to rise to £944 billion by the end of 2010 as the gap widens between government spending and revenues as the countries GDP contracts, and the revenues from the booming financial sector evaporate into thin air. The situation has now been made worse by the £20 billion tax cut.
Northern Rock Nationalisation
The estimated exposure at the end of 2007 was £40 billion, however by the end of 2008 this will have risen to £90 billion following the banks nationalisation and ongoing housing market crash.
Continue to read: http://www.globalresearch.ca/index.php?context=va&aid=11207
-- John Kemp is a Reuters columnist. The opinions expressed are his own. –
The United States and the United Kingdom stand on the brink of the largest debt crisis in history.
While both governments experiment with quantitative easing, bad banks to absorb non-performing loans, and state guarantees to restart bank lending, the only real way out is some combination of widespread corporate default, debt write-downs and inflation to reduce the burden of debt to more manageable levels. Everything else is window-dressing.
To understand the scale of the problem, and why it leaves so few options for policymakers, take a look at Chart 1 (https://customers.reuters.com/d/graphics/USDEBT1.pdf), which shows the growth in the real economy (measured by nominal GDP) and the financial sector (measured by total credit market instruments outstanding) since 1952.
In 1952, the United States was emerging from the Second World War and the conflict in Korea with a strong economy, and fairly low debt, split between a relatively large government debt (amounting to 68 percent of GDP) and a relatively small private sector one (just 60 percent of GDP).
Over the next 23 years, the volume of debt increased, but the rise was broadly in line with growth in the rest of the economy, so the overall ratio of total debts to GDP changed little, from 128 percent in 1952 to 155 percent in 1975.
The only real change was in the composition. Private debts increased (7.8 times) more rapidly than public ones (1.5 times). As a result, there was a marked shift in the debt stock from public debt (just 37 percent of GDP in 1975) towards private sector obligations (117 percent). But this was not unusual. It should be seen as a return to more normal patterns of debt issuance after the wartime period in which the government commandeered resources for the war effort and rationed borrowing by the private sector.
From the 1970s onward, however, the economy has undergone two profound structural shifts. First, the economy as a whole has become much more indebted. Output rose eight times between 1975 and 2007. But the total volume of debt rose a staggering 20 times, more than twice as fast. The total debt-to-GDP ratio surged from 155 percent to 355 percent.
Second, almost all this extra debt has come from the private sector. Take a look at Chart 2 (https://customers.reuters.com/d/graphics/USDEBT2.pdf). Despite acres of newsprint devoted to the federal budget deficit over the last thirty years, public debt at all levels has risen only 11.5 times since 1975. This is slightly faster than the eight-fold increase in nominal GDP over the same period, but government debt has still only risen from 37 percent of GDP to 52 percent.
Instead, the real debt explosion has come from the private sector. Private debt outstanding has risen an enormous 22 times, three times faster than the economy as a whole, and fast enough to take the ratio of private debt to GDP from 117 percent to 303 percent in a little over thirty years.
For the most part, policymakers have been comfortable with rising private debt levels. Officials have cited a wide range of reasons why the economy can safely operate with much higher levels of debt than before, including improvements in macroeconomic management that have muted the business cycle and led to lower inflation and interest rates. But there is a suspicion that tolerance for private rather than public sector debt simply reflected an ideological preference.
THE DEBT MOUNTAIN
The data in Table 1 (https://customers.reuters.com/d/graphics/USDEBT3.pdf) makes clear the rise in private sector debt had become unsustainable. In the 1960s and 1970s, total debt was rising at roughly the same rate as nominal GDP. By 2000-2007, total debt was rising almost twice as fast as output, with the rapid issuance all coming from the private sector, as well as state and local governments.
This created a dangerous interdependence between GDP growth (which could only be sustained by massive borrowing and rapid increases in the volume of debt) and the debt stock (which could only be serviced if the economy continued its swift and uninterrupted expansion).
The resulting debt was only sustainable so long as economic conditions remained extremely favorable. The sheer volume of private-sector obligations the economy was carrying implied an increasing vulnerability to any shock that changed the terms on which financing was available, or altered the underlying GDP cash flows.
The proximate trigger of the debt crisis was the deterioration in lending standards and rise in default rates on subprime mortgage loans. But the widening divergence revealed in the charts suggests a crisis had become inevitable sooner or later. If not subprime lending, there would have been some other trigger.
The charts strongly suggest the necessary condition for resolving the debt crisis is a reduction in the outstanding volume of debt, an increase in nominal GDP, or some combination of the two, to reduce the debt-to-GDP ratio to a more sustainable level.
From this perspective, it is clear many of the existing policies being pursued in the United States and the United Kingdom will not resolve the crisis because they do not lower the debt ratio.
In particular, having governments buy distressed assets from the banks, or provide loan guarantees, is not an effective solution. It does not reduce the volume of debt, or force recognition of losses. It merely re-denominates private sector obligations to be met by households and firms as public ones to be met by the taxpayer.
This type of debt swap would make sense if the problem was liquidity rather than solvency. But in current circumstances, taxpayers are being asked to shoulder some or all of the cost of defaults, rather than provide a temporarily liquidity bridge.
In some ways, government is better placed to absorb losses than individual banks and investors, because it can spread them across a larger base of taxpayers. But in the current crisis, the volume of debts that potentially need to be refinanced is so large it will stretch even the tax and debt-raising resources of the state, and risks crowding out other spending.
Trying to cut debt by reducing consumption and investment, lowering wages, boosting saving and paying down debt out of current income is unlikely to be effective either. The resulting retrenchment would lead to sharp falls in both real output and the price level, depressing nominal GDP. Government retrenchment simply intensified the depression during the early 1930s. Private sector retrenchment and wage cuts will do the same in the 2000s.
BANKRUPTCY OR INFLATION
The solution must be some combination of policies to reduce the level of debt or raise nominal GDP. The simplest way to reduce debt is through bankruptcy, in which some or all of debts are deemed unrecoverable and are simply extinguished, ceasing to exist.
Bankruptcy would ensure the cost of resolving the debt crisis falls where it belongs. Investor portfolios and pension funds would take a severe but one-time hit. Healthy businesses would survive, minus the encumbrance of debt.
But widespread bankruptcies are probably socially and politically unacceptable. The alternative is some mechanism for refinancing debt on terms which are more favorable to borrowers (replacing short term debt at higher rates with longer-dated paper at lower ones).
The final option is to raise nominal GDP so it becomes easier to finance debt payments from augmented cashflow. But counter-cyclical policies to sustain GDP will not be enough. Governments in both the United States and the United Kingdom need to raise nominal GDP and debt-service capacity, not simply sustain it.
There is not much government can do to accelerate the real rate of growth. The remaining option is to tolerate, even encourage, a faster rate of inflation to improve debt-service capacity. Even more than debt nationalisation, inflation is the ultimate way to spread the costs of debt workout across the
widest possible section of the population.
The need to work down real debt and boost cash flow provides the motive, while the massive liquidity injections into the financial system provide the means. The stage is set for a long period of slow growth as debts are worked down and a rise in inflation in the medium term.
For previous columns by John Kemp, click here.