UK's balance of payments is a big issue - and getting bigger:

 

We are on track for a currency crisis – and bankruptcy

Our leaders fail to grasp that taking back control also means taking back responsibility

JEREMY WARNER2 July 2022 • 12:00pm

Britain's current account deficit is easily the biggest such deficit ever CREDIT: Yui Mok /PA

Jeepers! We may be all tightening our belts in response to the cost of living squeeze, but as a nation, we are still spending far more than we are earning. Indeed, we are doing so in record amounts.

Living beyond our means has long been a national habit, so it shouldn’t perhaps come as any surprise. The sheer size of the addiction is nonetheless quite a shock.

According to the latest national accounts, published last week, Britain’s current account deficit widened in the first quarter of this year to an astonishing 8.3pc of Gross Domestic Product, easily the biggest such deficit ever.

In layman’s terms, what this means is that overall expenditure in the UK is exceeding national income by nearly a tenth of the value of the entire economy.

All other things being equal, there would be nothing left at all in the national coffers in little more than ten years from now if we were to carry on like this.

Fortunately, the balance of payments doesn’t work quite like that; the deficit is paid for by inflows of capital from overseas, so the fact that we are still able to finance such a high level of consumption might be taken as a vote of confidence in the UK, rather than a cause for panic.

What is more, the Office for National Statistics has changed the way it collects the data, which may make the deterioration look worse than it really is. 

All the same, the situation looks alarming enough; even excluding sales of gold and other precious metals, which can be volatile, the deficit was still an eye watering 7.1pc, against an average of just 2.6pc last year.

It is hard to be certain about the exact causes of this deterioration. Certainly the soaring costs of imported energy and food were a major factor. But the UK also exports quite a lot of oil and gas, so there was a big offset in this regard.

The main factor was instead a big leap in imports of finished and semi manufactured goods. There was also a marked deterioration in exports of goods, though not as large as the increase in imports. Whatever ministers say to the contrary, it is hard to escape the conclusion that this is at least in part a Brexit effect. 

As demand came surging back, post the pandemic, the flaws in Boris Johnson’s “oven ready” trade deal with the EU have been cruelly exposed.

The EU trades pretty much freely with us - our choice, by the way, so as not to further add to inflation with increased bureaucratic restrictions on trade - but our exports to them are already encountering the full panoply of barriers that afflict non EU members that are not part of the single market.

The surge in imports may also have something to do with acute labour shortages in key sectors. British companies may as a consequence have found it harder to satisfy domestic demand than otherwise. 

In any case, there is no denying where the balance of power in our new trading relationship with Europe lies; it is predictably with the much larger jurisdiction - the EU. So much for the much touted claim that because we import far more from them than they do from us, Britain would maintain the whip hand in any ongoing relationship.

The total trade deficit has widened

Combination chart with 4 data series.

The chart has 1 X axis displaying Time. Data ranges from 2019-03-01 00:00:00 to 2022-03-01 00:00:00.

The chart has 1 Y axis displaying £bn. Data ranges from -62.2 to 37.

£bnTrade in goods balance (excluding precious metals)Total trade balance (excluding precious metals)Total trade balance (including precious metals)Trade in services balanceJul '19Jan '20Jul '20Jan '21Jul '21Jan '22-75-50-2502550SOURCE: ONS

THE TOTAL TRADE DEFICIT HAS WIDENED

End of interactive chart.

Small wonder that the Government still refuses to commission an economic impact assessment of Brexit; the findings would not reflect well on our exit deal.

In the circumstances, it is perhaps a surprise that the pound is not under more pressure in foreign exchange markets than it is. So far this year, it has fallen more than 10pc against the dollar, but it has been broadly flat against the euro, and is off only 3pc on a trade weighted basis.

There is little sign as yet of a fully blown currency crisis, where interest rates have to be jacked up precipitously to guard against the inflationary consequences of a collapsing pound.

A big current account deficit doesn’t necessarily matter if there are enough investors willing to finance it with inflows of capital. But it does leave the country reliant on what Mark Carney, former Governor of the Bank of England, called “the kindness of strangers”.

For the moment, there seems to be no particular problem in this regard, despite the rising interest rate differential with the US. Anecdotally, there is still a long queue of foreign buyers looking to buy up British companies, and even to invest in UK Government debt. Net investment in the UK increased by £158.9 billion in the first quarter.

It may be that appetite for British assets is about to plummet, but this is by no means set in stone. Those who think that UK gilts are “sitting on a bed of nitroglycerin”, as the self styled bond king, Bill Gross, famously said of them at the time of the financial crisis, should consider this; Britain is virtually alone in the world in having never defaulted.

Theoretically more creditworthy countries such as the US and Germany most certainly have, the latter massively on at least four occasions in the last century. This enviable and almost unique record of creditworthiness is not something the UK Treasury is about to surrender. However bad things get, Britain will always pay its debts.

Nonetheless, looking at the latest balance of payments statistics, there are some worrying straws in the wind that are eventually going to require huge and politically difficult changes in policy. 

Portfolio investment overseas decreased by £103.6bn in the first quarter, reflecting a quite widespread sale of overseas shares. This is tantamount to selling off the family silver to finance current consumption, and is plainly not sustainable on an indefinite basis.

The ONS also struggled to reconcile the recorded current account deficit of £55.7bn with the £29.6bn of net inflows. Since the balance of payments must by definition always balance, the shortfall is listed as unexplained “net errors and omissions”.

Either the current account deficit is not as big as reported, or there is another possibly quite unstable source of inflow which is not being recorded.

Whatever the truth, the UK plainly cannot keep running up current account deficits of this order of magnitude indefinitely, or for that matter expect the rest of the world to keep financing them - not in any case while it remains a relatively high tax, big state economy. 

Taking back control also means taking back responsibility, and yet our Brexiting Government doesn’t seem to have grasped the fact. The remorseless logic of Brexit is that of the small state, low tax economy, yet we seem headed in the opposite direction. Uncorrected, our present trajectory can only end in a currency crisis and bankruptcy.

To finance a trade deficit of the current size, and eventually bring it back into balance, you need to attract a lot of foreign investment. You do not go about this task by whacking up income tax, corporation tax, and other forms of business taxation. Let’s hope that we don’t require another mega crisis for this brutal truth to sink in.

SPICED vs WePIDEC - what's up with the £?

 

Some very useful exchange rate info here - it is much more than a question of moving interest rates around:

Bank of America is wrong about the weak pound

The story so far is essentially one of dollar strength, rather than sterling weakness

JEREMY WARNER5 June 2022 • 6:00am

Jamie Dimon, boss of JP Morgan Chase, thinks an economic hurricane is coming. Announcing a one in ten headcount reduction at Tesla, Elon Musk says he has a “super bad feeling” about the economy. John Waldron, chief operating officer of Goldman Sachs, warns that markets have yet to come to terms with the current, unprecedented confluence of economic shocks.

Amid it all, the UK is said to be in a particularly difficult position. So claims Kamal Sharma, foreign exchange strategist at Bank of America. International investors are increasingly of the view that the pound sterling has taken on emerging market characteristics, he warns.

I’m not sure about Dimon’s hurricane or Musk’s “super bad feeling”. Perhaps they are right, though it is worth noting that both these pundits are quite late to the party. Predictions of catastrophe have been the presiding narrative for some months now, and it hasn’t happened yet.

But I do take issue with the idea that the pound is about to undergo some kind of fundamental repositioning that destroys its remaining reserve currency status.

This is not to argue it’s impossible. There have been many such moments of currency reappraisal in Britain’s long retreat from empire. 

In 1931, just before Britain abandoned the gold standard, a pound would have bought you 4.87 US dollars. Immediately afterwards, your pound was worth a considerably reduced but still respectable $3.69. Unfortunately, that was just the beginning. The next big devaluation was in 1949; this was a whopper which reduced the value of the pound by around 30 percent and essentially marked the end of sterling’s reign as the world’s pre-eminent currency for international trade

Against this, Harold Wilson’s famous “pound in your pocket” devaluation was a comparatively minor event - “just” 14 percent to $2.40. After that came the collapse of the Bretton Woods fixed exchange rate regime in the early 1970s, when there was another stomach churning downward lurch. All of these post war devaluations reflected an increasingly harsh reality — that the British economy was progressively losing international competitiveness, resulting in repeated balance of trade crises.

Just to bring things up to date, there have since been three standout such moments - the ERM debacle in 1992, the financial crisis in 2008/9, and the vote for Brexit in 2016. 

The position has been relatively calm since the last of these episodes, with the pound bouncing around within a quite narrow range of about 10 percent against both the dollar and the euro. Until the beginning of this year, that is. 

Since then, the pound has been the world’s third worst performing major currency, after the Swedish krona and the Japanese yen. There is obvious potential for things to turn uglier still. All the same, the story so far is essentially one of dollar strength, rather than sterling weakness. Against the euro, the pound has lost only a couple of cents, and the trade weighted index is actually marginally up on the year.

This is not to lightly dismiss Bank of America’s analysis, which raises important concerns about sterling’s continued credibility as a reserve currency. Obvious failings in the Bank of England’s inflation targeting regime have left policymakers in the invidious position of having to raise interest rates into a fast slowing economy — never a great look and often symptomatic of a downward spiral in the currency.

As Bank of America’s Sharma points out, this makes the Bank’s position notably different from that of the Federal Reserve in the US, which is raising interest rates against the backdrop of a still strong economy. Rightly or wrongly, there have also been questions over the Bank of England’s independence. Too often it seems a creature of the Government’s need for deficit financing.

But the Bank’s credibility is just the half of it. Since Britain left Europe’s single market, there has been a notable deterioration in the country’s external trade position, bringing back memories of previous balance of payments crises. 

Even a widening trade deficit doesn’t really matter provided there is sufficient in the way of capital inflows to finance it. But if these start to wane, then the currency is going to be in some difficulty.

Throughout much of last year, when there was a general perception that UK assets were undervalued by comparison with peers, this wasn’t much of a problem. The money flowed in as required, and the exchange rate actually appreciated somewhat.

But this undervaluation may now have gone, and with rising interest rates more of less everywhere, UK assets may have lost some of their comparative appeal. 

Global liquidity conditions are deteriorating, and with interest rate normalisation, net cross border flows have slowed. With such a large current account deficit, Britain is particularly reliant on “the kindness of strangers”, and therefore vulnerable to any loss in international confidence.

All this is no doubt true. Brexit has made trade with Europe, still the UK’s largest external market, more difficult and costly, while the UK Government has so far failed to demonstrate meaningful economic gains to compensate. 

The Government’s refusal, moreover, to acknowledge that Brexit has played any part in deteriorating trade only further inflames the situation, making it look as if ministers have their heads buried in the sand.

But here’s where it is reasonable to take issue with the Bank of America analysis. All things are relative in currency markets, and looking around the world today, you would struggle to find a jurisdiction where things look notably better.

Run by an indecisive geriatric, paralysed by an increasingly dysfunctional political system, and torn apart by the poison of its culture wars, the US seems of ever less appeal beyond its traditional reserve currency attributes. 

The EU? Slow moving and severely compromised by its 27 moving parts, it is more exposed than any to the debilitating effect on energy prices of the Ukrainian war. Besides, with rising interest rates, the eurozone debt crisis will be back before we know it. Spreads are already widening worryingly.

As for China, what on earth is the regime playing at? The anti-Western rhetoric alone would be enough to deter all but the bravest of investors. Add in the zero-Covid debacle, the crackdown on tech, on the education sector, on Hong Kong and on the Uighurs and you’d reasonably conclude that China’s economic miracle is over.

In any case, set against the alternatives, the UK doesn’t seem such a bad place for your money. Witness the great outpouring of affection for the monarchy, its institutions still seem relatively robust, and although the fiscal position looks precarious, it is by no means beyond redemption.

There is admittedly no discernable strategy behind the current chaos of intellectually bankrupt policy making, but that seems to be the case more or less everywhere. Can it really be that difficult for a Tory Government to provide the pragmatically driven and predictable policy framework that is required for enterprise to thrive? Sort that out, and so would sterling.

Short article on pros and cons of FDI

American investors have feasted on British technology businesses in record numbers, helped by the weak pound and a lack of funding for later-stage companies.

Tech companies received $4.4bn (£3.4bn) from US venture capital funds in the first 10 months of the year, against $4bn for the whole of last year, according to figures released this week. It is the highest investment level on record, says the research provider, PitchBook.

The data is being published as part of Silicon Valley Comes to the UK (SVC2UK), an annual series of events that seeks to build relationships between Britain’s entrepreneurs and America’s biggest technology investors.

The numbers were welcomed as a sign that the UK is producing high-quality tech companies, but will stoke concerns about losing control of our best businesses before they have developed in full.

This year, there have been bumper US -led funding rounds for the challenger bank Monzo, which raised $144m, and OneTrust, a developer of data privacy software that got a $200m investment.

British start-ups have no problem attracting funds in the early stages, but often struggle to find the cash required to scale up their operations. Drawn by the weak pound and a growing number of promising tech businesses, US venture capitalists are filling the funding gap.

“We should be excited that they’re over here, but a little bit nervous as well,” said Sherry Coutu, the serial investor who was an early backer of Lovefilm and LinkedIn and co-founded SVC2UK. “If the cash comes from the US, often that will increase the likelihood of [the company] being redomiciled and floated in a different country.”

She added: “It is a problem for the economy. If a large amount of the cash goes in at a later stage because we don’t follow on in our investing, and you get a tremendous return, then that money doesn’t go into UK pockets and it’s less likely it will get reinvested here.”

Britain is by far the most attractive destination for US venture capital investment in Europe, according to PitchBook. In the past five years, the UK has received $17.8bn from American funds, compared with $10.5bn for Germany in second place and $5bn for France in third.

London has attracted $3.5bn of investment this year, by far the highest amount for a city in Europe. Three of the top 10 cities for American investors — London, Cambridge and Oxford — are in Britain.

“For the UK to punch above its weight in tech globally, we have to attract capital from across the world,” said James Wise at Balderton Capital, a London-based investor that backed Revolut.

“While obviously it would be even better if more UK companies grew to be large and profitable . . . in their own right, foreign investment and acquisitions ultimately still create jobs, provide training and develop software that can have radical benefits to everyone in the UK, irrespective of where those funds originate.”