FYI | Apr 23 2009
By Greg Peel
It was Napoleon who once described Britain as a nation of shopkeepers, but the Industrial Revolution turned the United Kingdom into a formidable powerhouse. Over time British industry has been largely dismantled, and merchants have mostly moved on. London was always a major world banking centre, and despite what New Yorkers might tell you, London remains the world’s largest today. Now the GFC has brought Britain to its knees.
“You can grow your way out of recession. You cannot cut your way out,” Chancellor of the Exchequer Alistair Darling told the British parliament last night. “We have made our choice to help people now, to build Britain’s future”.
Darling is most famous amongst Britons for being relentlessly bland, but clearly he is not beyond the politician’s craft of spin. Darling has to date poured billions into fiscal stimulus, has nationalised half of the UK banking system, and endorsed quantitative easing by the Bank of England. Prime Minister Gordon Brown, in the meantime, was an ardent campaigner ahead of the recent G20 meeting as he pushed to unite the world’s major economies in a policy of global stimulus. Resistance from Europe meant Brown’s campaigning was less than successful, but with the US and others on side a compromise was reached that the world would stimulate the IMF instead.
President Obama is a big fan of stimulus of course, having endorsed trillions in spending while still stating an intention to reduce America’s vast fiscal budget as soon as possible. Australia is also onside, as Kevin Rudd is expected to announce a third major stimulus package in Australia’s upcoming budget, further turning a once large surplus into deficit. But it was always apparent Gordon brown was trying just a bit too hard to garner global endorsement. His party is severely under threat in the wake of the GFC and he needed to prove to his people his government was doing the right thing.
Brown probably also had an inkling of what was soon to come. Last night his chancellor brought down a budget which shocked the nation. In the last fiscal year, Britain budgeted for a 90bn pound deficit. This fiscal year the deficit will reach 175bn pounds, or an extraordinary 12.4% of GDP. Never has Britain spent so much in peacetime. Six months ago Darling projected that Britain would need to borrow a total of 226bn pounds by 2013. That figure has now blown out to 606bn.
Darling’s speech to parliament was aimed at justifying such extensive borrowings as being necessary in order to finance sweeping spending plans intended to “help” and “build” Britain. These include a credit insurance scheme for businesses suffering from withdrawal of insurance, a 2000 pound incentive to trade in an old car for a new one (a la Germany), various programs to boost jobs training, particularly for youth unemployed, an extension of the stamp duty holiday on house sales, mortgage payment holidays for the newly unemployed, tax deferment for struggling businesses, a strategic investment fund for innovative businesses, and a fund to encourage small oil and gas field development in the North Sea.
A grand plan indeed.
The problem is, economists have described the plan as “meaningless”. All up the spending binge totals a mere 0.5% of GDP. That leaves 11.9% which isn’t related to fresh stimulatory spending. The problem for Britain is tax receipts have collapsed and the cost of existing spending programs have blown out as a result of the GFC.
In order to pay for the budget, the government will raise the income tax on those earning 150k pounds or more from 45% to 50%. While this will help, it reeks of being more of a political exercise to appease the working masses. More significantly, Britain will issue a much larger than expected 220bn pounds of gilts (long bonds) in 2009-10.
Britain’s economy is in dire straits. Darling revised his forecasts last night, and now expects GDP to contract by 3.5% in 2009 followed by a small gain of 1.25% in 2010. However he projected healthy growth of 3.5% by 2011 and beyond, and a reduction in the budget deficit to 5.5% of GDP by 2013-14. The current recession in Britain, suggested Darling, will end at the end of 2009.
The economists at Standard Chartered agree that the UK recession could end by year end. However, they question Darling’s 3.5% GDP growth projection for 2011, suggesting the economy will remain weighed down by such an extent of “fiscal retrenchment”. Standard Chartered expects the 2010-11 budget to show debt at 15.2% of GDP, and that’s only if growth in 2010 doesn’t disappoint.
Last night’s economic forecast update from the IMF put Britain’s 2009 economic contraction at 4.2% compared to Darling’s 3.5%. British economists have already criticized Darling’s projections as unrealistic. They rely “almost entirely on the assumption of a rosy scenario,” one economist told Dow Jones, and 3.5% growth in 2011 “is about double what most economists are expecting”.
Darling has spun his budget as necessary means for Britain to spend its way out of recession. However, spending has hardly been increased. All that has significantly been increased is debt, and in the meantime UK house prices continue to collapse and unemployment continues to rise.
Unsurprisingly, the pound took a bath last night against the greenback. The good news, nevertheless, is that a lower pound increases Britain’s export competitiveness and increases the value of offshore receipts. Hence the current account deficit is rapidly reducing, and given the pound is already at historical lows Standard Chartered sees the currency regaining value in 2010 after an initial devaluation.
But is this Britain’s darkest hour?
