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iiblack

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  1. The simple mathematical reality is that after many decades where global change bestowed great fortune on the UK, its long-ignored balance of payments problem is now set to cause immense chaos and societal change in coming years. In my career in hedge funds I traded mortgage bonds, including through the credit crisis of 07/08 and this gives me great insight into the nature of what is now afoot in the UK. The UK economy is like no other I know. It simply doesn’t work like other economies which is why so few understand it. Most leading economists (alongside politicians and journalists) choose to ignore its terrifying and ever spiraling balance of payments crisis because they can’t incorporate this unpredictable ticking time-bomb into their short-term outlook or forecasts. Many countries, including Japan and much of southern Europe, have horrific balance sheets. From most perspectives (though not all), the UK has a better balance sheet. The problem the UK has is cashflow and this is what makes it so unusual amongst leading economies. Cashflow is ultimately what takes you down, whatever your credit rating, life gets difficult when you can’t find the money for the rent and can’t afford food for your family…..In the case of the UK a vast torrent of money leaves the country every day – mainly in the form of interest, dividends, rent (on British assets owned by foreigners) and payment for imports. Far less of these things comes back – this is our vast balance of payments crisis which means a big chunk of the economy, over 5% of GDP in recent years, is lost to the rest of the world every year. You don’t need to be an economist to realise this isn’t sustainable What balances this immense outflow and keeps the UK solvent and able to ‘pay the rent’? Inflows of money from foreigners abroad, what else? Mainly purchases of British assets – such as giant swathes of London property. Also loans from foreigners – such as the purchase of government Gilts. What matters is that these immense inflows are not being invested productively in the British economy, they are simply being used to fund the cash pouring out. In this way more and more of the economy becomes owned by foreigners and more and more return must be paid out of the economy to these foreigners every year. Look at the British Office for National Statistics graph of Britain’s balance of payments deficit from 1955 to the present and you see it spiralling exponentially (See ONS graphs), not just in absolute ₤ terms but crucially also as a percentage of GDP. This illustrates graphically the catastrophic scale of the cancer growing at the heart of the British economy. If nothing changes then within ten years the UK will have transferred ownership equivalent to over 50% of its economy to foreigners – well before then it will have failed at the futile game of selling ever-greater pieces of itself off to service its debts. The consequences of this for the economy and the currency are grave What led to this situation? In many ways it is the innate attractiveness of Britain that allowed this imbalance to grow for decades when in other countries it simply never could have. The uniquely respected British legal system and the stability of British politics provide enormous security to foreign investors that they struggle to find elsewhere. Since the mid-1980s and the abolition of capital controls, capital has been on the move and the world loves the UK brand. Thatcher’s monetarism raised interest rates long and hard to control inflation and the vast bonanza of North Sea oil began to flow, together keeping Sterling at levels which made much of British industry uncompetitive and laid waste vast tracts of formerly industrial northern England (since when England simply doesn’t make all that much). Ever since the millenium a vast influx of foreign investment, from Russia, the Middle East and beyond, poured into London property. And even gilts became a haven as Europe entered its (first) decade of crisis. Before the 1980s small balance of payment deficits would frequently lead to sterling crises. But from the 1980s onwards the world has financed the cancer to grow unchecked, to now monstrous proportions. But North sea oil production has now collapsed, can the UK keep selling London houses forever to keep the cash flowing? As for Brexit, it may mean the point at which world is no longer able or inclined to support this British Ponzi scheme is coming far sooner. If that is the case then my view is better that the Ponzi ends now rather than later when it will have grown exponentially Ultimately sterling has to weaken dramatically until the point arrives when the world wants to invest in productive capacity in the UK (rather than simply buy UK assets). This means, amongst other things, investment to build companies that pay employees, pay taxes and which may generate exports – and a UK that no longer haemorrhages so much into payments for imports. This would be a rebalancing of the current account deficit. Given the stability of the UK and its institutions, its fairly well educated population and relatively low tax economy, this rebalancing should be forthcoming when sterling remains low enough for long enough. Those vast tracts of indsutrial wasteland in northern England might then see new industrial businesses sprouting up But there are great risks that the transition from Ponzi to real economy might be brutally hard. Above all else a huge property bubble has engulfed London and the south of England (home of the majority of UK GDP) with affordability falling to record lows as house prices reach nose-bleed valuations and house-price-to-earnings ratios reach levels never seen before. A culture has arisen similar to that seen in the US before the 2007 housing crash with a certainty that house prices can only rise and people wishing to throw every penny of their investment at the market. Who can blame them when even the Bank of England chief economist tells people not to bother with pensions but to buy houses instead. Whilst a lack of housing supply is often cited, low interest and mortgage rates are driving the bubble. As Albert Edwards explains, were lack of supply the primary driver, rents like house prices, would be rising well in excess of CPI, whereas they have broadly risen in line over the last ten years. When the UK loses control of its current account it will lose control of interest rates and will need to raise these to protect its currency and maintain basic living standards. At this point the floating mortgage rates of the UK will rise sharply and the decline in sterling resulting from this event will lead to inflation in costs which would severely diminish the earnings of individuals free to service rent or mortgages Lets remember that most British property by value is owned by the Boomers – the generation born in the two decades after the war and greatest beneficiary of the housing boom and bubble – over 2,000 of whom now celebrate their 70th birthday everyday in the UK. Their life expectancy is now thankfully high, to well into their eighties, but few have more than modest savings or pension provision (although a lucky fraction have generous defined benefit pensions). In embarking on additional Quantitative Easing (printing money to buy gilts) since Brexit, the Bank of England has crushed long-term gilt rates which has devastated the solvency of defined benefit pensions schemes and the companies that must support the schemes. It also means annuities now pay almost nothing. To support themselves over the remainder of their life it is inevitable that most pensioners will turn sooner or later to the asset all or most of their wealth is tied up in – their house. The store of equity accumulated in British property may well soon be drawn upon on a net basis for the first time. My concern is that whether through interest rate rises in a current account crisis or simply through the need for Britains to draw on their property wealth in retirement, the bubble will burst and a downward spiral in prices will begin. That could then lead to foreign investors selling their British assets to withdraw capital from the economy which would devastate the currency and current account still further. Property is the second layer to the great British Ponzi, it is simply unlikely there will be enough wealth generation elsewhere in private Britain in coming years to avoid it being plundered as an asset class to support life-long living expenses amongst a public whose wages have been dropping or stagnating in real terms for almost a decade For those who instantly respond that the Bank of England could simply print more money or cut interest rates (negatively if necessary) to support the property market, realise that in a current account crisis they absolutely cannot do so. It would be adding fuel to the fire and in these circumstances they will be doing everything they can to support sterling to keep shop shelves full and petrol stations pumping, not to weaken it. Until then the Bank of England is doing all they can to repress sterling yields and to weaken sterling, for which the Brexit vote provided them with much ammunition, in the hope that a greatly depressed currency will cause an industrial rebalancing before the onset of a current account crisis. For me, it may delay the crisis but the arithmetic is stark and unchanged The Bank of England need to be very careful, currently Britain is expecting the rest of the world to finance its vast twin deficits, to finance its current account deficit and to finance much of its fiscal deficit at negative real interest rates – with inflation exceeding the return paid – which is equivalent to living on handouts. If we were running a current account surplus as Europe does, we might well be able to embark on a fiscal stimulus adventure, perhaps in infrastructure spending, but for a country that is completely reliant both on low rates and on the rest of the world to tide itself over this would be suicidally reckless. In the event of a current account crisis the British fiscal deficit and enormous national debt (fortunately fairly long-dated), which would need to be financed and rolled at prevailing interest rates could then become an issue of national solvency if markets concluded a debt spiral was unavoidable. Then we have the risk of a change of government – seemingly very unlikely at present though this could quickly change if the public were suffering in a crisis, had lost much of their home equity and felt they had little to lose. Or even over time if the proportion of homeowners simply continues to plunge. As I write Ladbrokes has Jeremy Corbyn as the favourite individual to succeed Theresa May as next prime minister at 5/1 – if this was to occur market confidence would be devastated The real question in all this is whether there is a sustainable economic model that the UK can migrate to without a severe and permanent diminution of its people’s living standards – and how it could navigate such a transition without a long and brutal adjustment Britain has come through darker times before and will come through these, stronger and more balanced than before. But the time for self-delusion over the reality of what Britain faces is over Full blog :-https://iiblack.wordpress.com/2016/08/16/example-title/
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