Is Britain really going bankrupt?

Some people have said that this blog takes a somewhat cynical view of business, the economy and the world of work. It’s not the first time I have had this feedback. My boss at the evil City firm I used to work for once described me as having a PhD in cynicism. So, for a change, this post takes a slightly more optimistic tone. Either that or I’m just being cynical about cynicism. Work that one out.

For months now, the newspapers have been full of gloom and doom about the economy. Many bloggers have followed the same line. I have been as guilty of this as anyone else. And, let’s face it, things look pretty bad. Today, statisticians have confirmed what we already knew; that the UK economy is in recession. Earlier this week, we learnt that the banks had even more toxic assets than they had previously admitted and that, therefore, another bail out would be needed. The pound has crumbled and the UK’s CDS rating, the amount that it costs investors to insure £10,000 of government debt against default, has shot up to £144.

Some people have even started to claim that the UK is heading for bankruptcy.

But, while things are certainly bad, talk of bankruptcy is a step too far. A few of the more level headed commentators put the collapse of the UK economy into perspective. For example:

As David Page, at Investec Securities, explained to FT Alphaville, it’s not like the UK’s economy is alone in its troubles. In fact, he says there are “no major economies that fill you with inspiration” – downgrades in the euro zone and the US needs another stimulus. As a result, it will be hard for UK sterling to slide very much more against any of these currencies.

At the current price level Page adds sterling is already far beyond fair value, so it’s actually at a very competitive rate. As for inflationary pressures, he says we’ve already suffered sharp lows for more than a month and there’s been no real inflationary follow through. Trade hasn’t picked up but that’s because trade has ground to a halt generally everywhere.

In other words, currencies only collapse relative to other currencies and, if all the world’s economies are in trouble, none of them looks especially good so there is only so far the pound can fall.

Others question the recent obsession with watching the sovereign CDS ratings. Indeed, analysts at Bank of America question whether insuring government debt against default is any use at all:

[S]uppose that sovereign CDS referencing the U.S. or the UK were to suffer a Credit Event. [That’s a default to you and me.] Under the financial calamity that likely would follow, it seems doubtful that the protection seller-e.g., a bank or dealer-would remain able or willing to pay principal to the protection buyer. As such, a “hedge” currently recorded is likely of little value….

Which is a long way of saying that, were America or, for that matter, Britain to reach a point where it defaulted on its debt, the world economy would be in such a state that there would probably be no-one left able to cover the insurance.

The CDS ratings for all countries have been rising and continue to rise, some faster than others, but as this chart shows, if the UK goes bankrupt, the probability is that much of the rest of the world will already have gone down the tube too. As the FT’s Tracy Alloway pithily concludes:

Stop preparing for Armageddon, you’ll all be dead anyway.

Up until a few months ago, CDS ratings were obscure market indices that few people even knew existed. But over the past year, watching the economic crisis has become a form of entertainment. As a friend of mine said, there is something hypnotic about it. It’s like watching a disaster movie – only you’re in it. People who, until recently, had no interest in finance or economics are now fascinated by currency movements, CDS ratings and Debt to GDP ratios.

And the British, of course, love a good crisis. There is something in our national character that likes a good moan and loves to say “I told you so” when things go wrong. We are naturally suspicious of effusiveness and optimism. This is, after all, the Not Bloody Likely society. It’s not surprising, therefore, that the British are more pessimistic than most other nationalities about the economic crisis. That doesn’t mean that our economy is any worse, just that we enjoy moaning about it more.

But the levels of panic and pessimism in the British media haven’t done us any favours. We are perhaps in slightly more of a mess than some comparable economies, thanks to our economy’s over-reliance on banking and financial services, but looking at the current figures, France and Germany both have higher ratios of debt to GDP than the UK does. 

The credit rating agencies seem to agree. Only yesterday they confirmed Britain’s AAA rating and Moody’s said that the UK is in no worse a position than any of the other major economies.

The banks, too, are in dire straits but, in all probability, some of the toxic assets they hold will still pay out. At the moment, despite the media hype, many of these assets still represent potential rather than actual losses.

As Camilla Cavendish says in today’s Times, Britain is not likely to go bankrupt unless we allow ourselves to be driven over the edge by panic.

Britain is not Iceland. Iceland is the size of Coventry. Britain is the fifth-largest economy in the world (although it also has the third-largest current account deficit). The pound is still a reserve currency that people want to buy, despite the efforts of the speculators. We are bankrupt only in the sense that we could not pay if all debts were called in right now – which is true of many countries. A falling pound will be good for exports, assuming there is someone to buy them. The UK’s credit rating was reaffirmed last week.

The only thing that could push Britain into bankruptcy would be a full-scale panic.

And those fuelling the panic have their own agendas:

On Monday Jim Rogers, co-founder of George Soros’s Quantum Fund, proclaimed that sterling was “finished” and that everyone should get out. On Tuesday, the hedge fund manager Crispin Odey declared Britain “bankrupt”. We can be pretty sure that both men are profiting handsomely by shorting, or betting against, sterling.

Others who warn of bankruptcy also have axes to grind. The Daily Mail and David Cameron just want to bash the government and Will Hutton wants to scare us into joining the Euro.

It is extremely unlikely that Britain will go bankrupt. If it did, many other countries would be in a similar situation and we’d be seeing a total meltdown of the world economy. Yes, things are bad but wallowing in pessimism, while it might have a perverse entertainment value, doesn’t actually do us any good. Most of those who are using the B-word are doing so to advance their own particular causes. We should treat their wild claims with the scepticism they deserve. As I said at the beginning of this post, it’s time to be cynical about the pronouncements of cynics.

Update: Kenneth Clarke has dismissed David Cameron’s claim that Britain is going bankrupt and has suggested that we all stop being so dramatic about our economic woes. There speaks the voice of wisdom.

Here is the full interview transcriptfrom the Andrew Marr show.

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17 Responses to Is Britain really going bankrupt?

  1. Pingback: Banditry » Blog Archive » Is Britain really going bankrupt?

  2. Robin says:

    You haven’t really addressed how Britain can double-triple the issuance of sovereign debt while countries that normally buy our debt are seeing their economies collapse (e.g. Japanese exports falling 35%).

  3. jonty says:

    I *think” the public starting to see through the press hype. (After all manufactured controversy is good..)

    A clothing factory near us closed recently, all workers out on the streets etc etc. TV crews interviewed the workers

    Interviewer “Have you noticed that business has been going downhill?”

    First Lady “We have had less and less to do for a long time, since last summer it started to go quiet”

    Interviewer (to second lady) “So this came out of the blue then?”

    Second lady (looks at friend with the look of – you just answered this didn’t you but I’d better give him the answer he wants)
    “yes – totally”

    Two ladies look at each other slightly puzzled and quick cut to interviewer with groups of confused looking people milling about in backing ground, waving at passing motorists etc etc followed by serious faced bloke from council.

  4. Rick says:

    Robin, is the UK going to, as you put it, “double-triple the issuance of sovereign debt”?

  5. Pingback: Some perspectives on the recession « Qmceconomics

  6. Robin says:

    Rick,

    Yes the government is going to, as I put it ,”double-triple the issuance of sovereign debt”.

    Or do you think it’s scaremongering to pay attention to the chief executive of the body that issues our sovereign debt?

    http://www.ft.com/cms/s/0/65ceb218-e825-11dd-b2a5-0000779fd2ac,dwp_uuid=6997947c-a442-11dd-8104-000077b07658.html

  7. Rick says:

    But according to the article in your link, the chief executive of the body that issues our sovereign debt doesn’t think raising that money will be a problem.

  8. Robin says:

    The ability to sell the debt is not a function of the publically-voiced opinion of the head of the DMO.

    So my question stands, how can we possibly hope to triple our issuance of sovereign debt while countries that normally buy our debt are seeing their economies collapse (e.g. Japanese exports falling 35%)?

  9. john b says:

    Because they’ll buy our debt instead of the debt of more heavily indebted economies: Britain’s debt to gross domestic product ratio is forecast to rise to close to 60 per cent – nearly half that of Italy, and less than Germany and France.

  10. Robin says:

    So, a little role play:
    You work for the japanese goverment. Your countries biggest employers are bleeding because of the collapse in exports. You are getting no tax receipts because of a collapse in corporate profitability. Your country has suddenly shifted from being a country running both a trade and current account deficit to one in deficit on both counts.

    The value of your investments in UK sovereign debt are collapsing by the hour, already at less than 50% of the value they had 18 months ago.

    What do you do? Do you sell your UK gilts to plug a whole in one of the many holes in your economy, or do you buy 3 times as much of them?

  11. Robin says:

    Jesus, me fail english? Unpossible!

  12. john b says:

    I’m assuming *someone*’s running a surplus, because of that whole “definitionally true” thing. So if not Japan, then China or Indonesia or wherever.

  13. Robin says:

    Fair enough, but the collapse in the existing value of UK gilts is hardly going to encourage those that are running surpluses. I imagine that the careers of those that have been keen on buying UK gilts are not doing great right now.

    The summing to zero of balances of trade is definitionally true, but not the summing of current account balances, and I can see a straighter line between current account surpluses and the purchase of foreign government debt than I can with trade surpluses.

  14. Robin says:

    OK, so over the last 18 months, UK gilts bought in:

    Japanese Yen: Value of existing UK gilts has roughly halved.
    Indonesian Rupiah: Down by ~ 25%
    Chinese Yuan: Down by ~40%
    Brazlian Real: Down by ~20%
    Euro: Down by ~30%
    Australian Dollar: Down by ~16%

    In every one of these countries you have groups of people who have been charged with buying foreign debt over recent years. Within these groups, those who chose euro-denominated bonds will have been rewarded with praise and promotion, even if they just got lucky. Those who chose UK gilts will face derision and demotion. Hardly the backdrop for a tripling in the demand for UK debt.

    (I’ve picked these fairly randomly, and put down every one I looked at)

  15. john b says:

    No, because that isn’t how civil services work. In each of those countries, the people will have been told by the government “you must keep n% of reserves in gbp, q% in $”, etc. Nobody will have been held responsible for the decline in gbp reserves in the way you describe, because nobody had that discretion in the first place.

    The only question arising will have been, following the decline, whether the government cuts the gbp reserve requirement, or whether the bank buys more gbp-denominated debt to offset the decline in reserves. That depends on the expected future fall in the gbp, not in what’s already happened to it.

    If foreign governments think that a) the US$ will collapse because the economic fundamentals are even worse than in the UK and b) having the euro as their only developed-world currency reserve is risky given the small-but-real chance of the whole thing falling apart, then increasing gbp reserves while the gbp is low against other currencies is a far-from-stupid idea.

  16. Pingback: On the British Government’s solvency | SKY ROCK INDIA

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