Monday, November 17, 2008

Firm Plus Flaccid Equals F-F-Fecked

Labour winters are always f-f-f-freezin'

So can we get away with Gordo's "tax giveaway"? Will the international capital markets stay cool? Or will we get whacked by one mutha of a financing crisis?

As regular readers will know, one of Tyler's must-read blogs is Prof Willem Buiter's Mavercon. LSE prof and ex-member of the Bank Monetary Policy Committee, Buiter has been excellent on the credit crunch, the bail-outs, and all points South. We don't agree with everything he says, but he always offers a serious and provocative analysis.

Last week he wrote a typically robust piece entitled How likely is a sterling crisis or: is London really Reykjavik-on-Thames? Noting that HMG is now effectively guaranteeing Britain's entire banking system, he highlights the massive extent of that commitment.

Here's his chart of UK banks' total liabilities relative to our GDP. The top line is banks' overall liabilities, and the lower line shows their foreign currency liabilities (superimposed on their virtually identical foreign currency assets):

As we can see, total liabilities are now well over 400% of GDP, with foreign currency liabilities well over 200%. Both have more or less doubled since Labour took power - an astonishing increase. And both have now landed squarely on the shoulders of us British taxpayers.

Buiter writes:

"The key question is, can the government meet all these fiscal commitments, whether firm or flaccid, unconditional or contingent and explicit or implicit ? Does it have the resources, now and in the future, to issue the additional debt required to meet the growing volume of up-front obligations it has taken on?"

Of course, in the best of all possible worlds, everything's fine. The crisis passes, the economy starts growing again, the banks don't need continued taxpayer guarantees, and everyone lives happily ever after. Hurrah!

But what happens if the best of all possible worlds doesn't come to pass? What happens if the guarantees get called? What if the banks' assets turn out to be worth a lot less than they purport to be worth? And what if all those foreign currency creditors rush for the exit, demanding their money back?

Sure, with sterling creditors, HMG can just make the Bank of England print some more fifty quid notes: it devalues the currency but governments in a debt corner have never worried about that. But when foreign currency creditors want their money back, that's an entirely different matter. They don't want sterling, and the government doesn't have a printing press for foreign currencies.

What you then get is a sterling collapse and a complete freeze on any new private capital inflows from abroad - who'd want to lend to a country which can only repay in a nose-diving currency?

Which might not matter that much if we didn't have a massive current account deficit. But we do - when last sighted it was running at 3% of GDP, or around £50bn pa - and unless we can continue to borrow we have to slash our imports back to banana republic cash-on-delivery levels. Which with all our imported energy, would make for a very cold winter indeed. Any takers for another Attlee winter (1947 -pic)?

Of course, longtime Labour supporters like Anatole Kaletsky scoff at such a scenario. They apparently believe that a big strong economy like ours can carry another £15-30bn on the annual fiscal deficit, no problem.

But read Prof B. He explains precisely how we could head the way of bankrupt Iceland - a relatively small economy whose banks have ballooned way out of proportion to everything else, where the government has effectively nationalised those debts, and where the foreign currency debts are beyond the resources of taxpayers to redeem.

And just a quick reminder: you are going to need thermal underwear, candles, and a large supply of hi-energy bars. Oh yes - nearly forgot - you also need to decide where you're going to emigrate to. Do it now.

PS The man who wants governments to increase their borrowings by 2% of GDP? Ah, that would be French Communist lothario Dominique Strauss-Kahn, a man whose 2007 appointment as IMF head underlined just how irrelevant the organisation had become.

Update: That Arctic winter is already on the way.

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