Is the UK heading for a currency crisis?
It’s the sort of problem you might have thought disappeared with the 1970s, but as the Coalition renews its wedding vows, that’s the unsettling possibility raised by economists at both HSBC (LSE: HSBA.L - news) and Royal Bank of Scotland (LSE: RBS.L - news) . With fears of a eurozone break-up, a calamitous fiscal contraction in the US, and a hard landing in China now fast receding, it is possible financial markets will refocus their attentions on more conventional concerns. The failings of the UK economy might be prime among them.
Some of the reasons for this need little explanation. Low growth has undermined attempts to reduce the fiscal deficit, which remains one of the highest in the OECD. This in turn is likely to lead to the loss of Britain’s prized triple A credit rating this year, making the UK comparatively less attractive to overseas investors. What’s more, capital flows from the eurozone to perceived “safe havens” such as the UK are slowing as the crisis eases. There is also evidence of elevated concern among investors about Bank of England money printing.
But some of the other reasons are less well appreciated, possibly because we’ve become so accustomed to them. Almost unbelievably, Britain has not enjoyed a trade surplus in goods since 1981, or more than 30 years ago. This long-standing weakness has been partially compensated for by a relatively large surplus on services, and on overseas income, but even so, Britain has been in overall current account deficit ever since the mid-1980s.
In other words, the UK has been persistently spending beyond its means. Despite the crisis, it shows few signs of changing its ways. The holy grail of a more balanced economy, with a greater proportion of GDP coming from net trade, remains as elusive as ever. It’s perfectly reasonable for economies in their development phase, when they are sucking in resource for long-term investment in infrastructure and job creation, to run trade deficits, but when the money is being blown on current consumption, both public and private, it becomes rather more problematic.
Rewind to when we were last in surplus all those years ago, and it roughly coincided with the advent of North Sea oil. In subsequent years, these revenues helped to cover up a steadily growing deficit in traded goods, and an accompanying loss of competitiveness against rival economies.
As many developing nations have discovered, the apparent windfall of natural resource can be as much a curse as a blessing, and, without doubt, the UK has squandered its good fortune. It’s a much smaller country admittedly, but the blue-eyed Arabs of the North, the Norwegians, have been much better both at eking out the benefits of their oil reserves and squirrelling them away for the future.
In any case, North Sea oil has helped the UK economy avoid what would otherwise have been brutally imposed market reform and adjustment. As recently as 2001, Britain enjoyed a trade surplus in crude oil of nearly £6bn a year. In 2011, the deficit was £10.7bn. Like a receding tide, fast depleting North Sea oil is exposing the underlying wreckage of the UK economy.
Mercifully, at least the trade deficit in other goods doesn’t appear to be getting any worse; indeed, it is hard to see how it could with domestic demand so depressed. But nor is it getting any better, and as Ross Walker of RBS points out, a new problem is beginning to emerge a possibly irreversible decline in the surplus on overseas income.
This has traditionally been quite strong for the UK, a relic of empire perhaps. Inflows from overseas portfolio investment and the foreign subsidiaries of British companies have been big contributors to the current account.
But just recently, these have come under sustained pressure. Such inflows tend to be quite volatile, so it is by no means certain that they are in seminal decline. All the same, there is one quite worrying reason for believing they might be.
Persistent current account deficits have to be funded somehow or other, either by borrowing from the rest of the world, or by foreigners buying other domestic assets companies, property and so on. It may well be that we are reaching a tipping point where the foreigners, as it were, own more of us than we do of them. We’ve not had figures for the final quarter of last year yet, and data for the third quarter were certainly a bit better that the preceding two. Even so, Ross Walker reckons we are heading for a current account deficit for last year of around 3.4pc of GDP, the highest since 1990.
If this were a one-off, it wouldn’t be much to worry about, but the last time the deficit was this high was in the dying days of the Lawson (Other OTC: LWSOF - news) boom, when the UK was sucking in imports like there was no tomorrow. That it can also happen in the midst of a double dip, or possibly even triple dip, recession makes it much more alarming.
What’s more, it is happening at a time when current account deficits in the eurozone periphery are fast correcting. In the second quarter of last year, Britain recorded a higher current account deficit than Spain, Italy, Portugal and even Greece, according to comparative data from Eurostat. Austerity-engulfed Ireland (OTC BB: IRLD - news) , meanwhile, achieved a surplus of an impressive 7.8pc.
You shouldn’t read too much into these differences. A current account surplus can be quite easily manufactured simply by collapsing internal demand, but if the price is double-digit unemployment, as it is throughout much of Europe, then it is not an economic outcome you would want to aspire to.
Ironically, policy measures in the UK to support domestic demand automatic fiscal stabilisers and quantitative easing may only have served to make Britain’s twin fiscal and current account deficits more persistent while helping to ease their counterparts elsewhere in Europe.
For the purposes of this column, I’m avoiding the “in/out” debate; suffice it to say that Britain’s current account problem is entirely with Europe and Asia. For the Americas, Australasia and Oceania, the UK has been in surplus ever since 1992.
It’s not clear the shortfall with Europe would be very much helped by exit from the EU, since whatever happened, Britain would presumably continue to trade substantially with its geographic neighbours. Nor does the solution obviously lie with further devaluation, though that may well be the upshot once financial markets begin to focus anew on these apparently intractable structural challenges.
Sterling has strengthened over the last year, but remains well down on pre-crisis levels. Unfortunately, this relative weakness hasn’t notably increased competitiveness. What it certainly has done, however, is add to inflation. Devaluation is a zero sum game, and certainly no substitute for the structural reform so desperately needed if Britain is ever going to improve its position in traded goods. On Monday, the Coalition said it aimed to double UK exports to £1 trillion by 2020. I wish them luck.