We are on track for a currency crisis – and bankruptcy
Our leaders fail to grasp that taking back control also means taking back responsibility
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.
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.
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