Thursday, December 04, 2008

Bring Out Your Debt

What happens when you borrow too much

Is there any private debt Brown/Darling won't force taxpayers to guarantee?

On top of the £6 trillion of bank debt he's already taken on, yesterday he started on the £1.5 trillion of household debt. True, the details of his £400 grand mortgage interest guarantee scheme seem particularly half-baked even by his standards, but the principle is clear - if they make enough noise, individual debtors can now look to the government to bail them out. Mortgages today - credit card bills tomorrow.

Unfortunately, in the real world, we taxpayers simply can't afford to pick up everybody's debt, and the financial markets are already making that clear.


Well, for every borrower there has to be a lender, and in our case the key lenders are overseas investors. Indeed, the only reason we've been able to build up all our debt in the first place is because overseas investors have let us.

The current account on our balance of payments tells the story. It measures the extent to which overall we're in surplus or deficit with the rest of the world - in simple terms, the extent to which we're paying our way. And the picture is grim:

As we can see, we are chronic borrowers: for much of the last half century Britain has run a current account deficit. But the position has got much worse.

Back in the days of fixed exchange rates (under the now much touted Bretton Woods system) our deficit never exceeded 1% of GDP, and even that was enough to make governments totter. But the move to floating exchange rates in the early 70s allowed us to borrow much more without triggering an immediate sterling crisis.

And we did. Over the past 8 years we have borrowed an average 2.5% of our GDP from foreign investors. In the most recent 12 months it was 3.5%, or £41bn. That's about £1,600 pa for every household - a loan from the Watanabes of Yokohama to the Brown's of Bracknell.

So what happens if foreigners decide they don't want to lend us so much?

Simple - they increase their price for doing so. Part of that increase takes the form of higher interest rates, which is why the cost of insuring UK government debt against default (Credit Default Swap rates) is now nearly three times higher than it is for German debt. But part of it takes the form of a fall in sterling, which is currently going down by the day.

And remember - whatever that shifty Mr Wislon may have told you about pounds in your pocket, lower sterling makes us all poorer. Our income and savings are worth less on world markets, and we have to pay more for everything.

Bottom line - simply by living in Britain, we are all going to pay a big price for continuing to borrow so much. The only way of escaping that is to switch your employment contract into yen, and move your savings overseas - better still, just emigrate.

In reality, our chronic borrowing habit will have to be curbed. Our current account deficit has suddenly become a burden we cannot carry. We will have to stop borrowing from foreigners.

It will be painful for all of us. But when it comes to divvying up the pain, there's no way taxpayers should be expected to pick up the pieces for every individual who's been living beyond his means.

PS Martin Wolf wrote an interesting piece yesterday highlighting the difficulties of rebalancing the world's current account positions (HTP KG). He included the following handy chart, summarising who's got the big surpluses and deficits:

The lower panel shows who's actually been doing the borrowing in the US. As we can see, the biggest borrower since 2000 is the government, although until recently, debt-pumped households haven't been far behind. And contrary to what it says in the economics textbooks, instead of borrowing to invest, business has been a net lender. It's been a broadly similar position here in the UK, as we can see in the comparable ONS chart (doesn't show foreign sector):

On both sides of the Atlantic, households have had one helluva borrowing binge.


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