UK’s economic cheese and debt pickle: James Saft

May 3, 2012

By James Saft

(Reuters) – Pity poor Britain: their own currency to depreciate, their own central bank to print and buy government debt, and yet here we have the second recession in three years.

Not only did GDP shrink by 0.2 percent in the first quarter – the second consecutive contraction, but a sickly manufacturing survey and a drop in exports both indicate that there is a risk of something more sustained and deeper.

And it’s not as if labor hasn’t been sharing the burden; unemployment is high and wage earners are taking home less in inflation-adjusted terms than they were in 2005. That leaves many British households struggling with debts which haven’t really shrunk and must be repaid while earning, effectively, less. Inflation is high, leaving even less for consumption, and households continue to show a preference for paying back money rather than borrowing.

Britain’s stab at austerity has been a genuine drag – public sector investment has shrunk markedly and austerity measures shaved about 0.7 percent off of GDP last year.

Economist Richard Duncan, author of The New Depression, sees Britain as being near the end of its rope; an economy which has depended on ever-increasing amounts of debt to generate growth.

“If their debt contracts, the economy collapses,” Duncan, a former World Bank official, said.

“The government is claiming that they are instituting austerity but they’ve really just touched the tip of the iceberg. If they have a real dose of austerity the economy won’t just go into recession but depression.”

And in truth, Britain’s anemic showing – its economy has shrunk in four of the last six quarters – has happened even as total debt in the economy has expanded. Total debt in the British economy sky-rocketed from 2000-2008, growing 177 percent, but carried on growing since, rising another 20 percent through the first half of last year, according to data from the McKinsey Global Institute. here

During that time households and non-financial corporations paid down debt but financial institutions and the government more than made up the slack. Those facts aren’t, in themselves, a policy prescription, but they illustrate very clearly one thing: if Britain has grown weakly while the growth of debt slows, it will very likely contract savagely when debt contracts across the economy.


And remember, too, this has all happened while the Bank of England has been very busy doing its part; buying up roughly a third of all outstanding gilts in an attempt to reflate the economy. That has only been of limited use. The BOE has been swimming against a tide where households and businesses would rather hold safe assets or pay down their debts than consume or invest.

That those debts are not shrinking in comparison to earnings only gives that cycle of thrift and austerity more impetus.

“There has been inflation in the UK. The real price of labor has not been sticky. The real burden of debt has fallen, sure, but real wages and incomes have fallen even farther, leaving people less able than ever to satisfy debts they’ve contracted and so purchase financial security,” economist Steve Randy Waldman writes in his blog. here#comments

“There is a lesson here. If we mean to pursue reflationary policy, the goal should not be to reduce real wages, but to reduce the real value of debt relative to incomes.”

That, by the way, may well work, but it is not even close to being on the cards for Britain, not politically and not in terms of how monetary policy is likely to be pursued.

The important point to note here – and this extends beyond Britain to the U.S. and Europe – is that debt is an extremely cumbersome and inflexible mechanism. It takes a long time for creditors and borrowers to re-set debt values and terms after a shock like 2008. Bankruptcy takes time and causes all sorts of negative external developments which may have little to do with the underlying viability of the business or household playing bluff with their creditors.

This all applies equally to the U.S. housing market, which may take a decade to fully clear, as it does to Britain.

Britain does have a bit of an excuse; its economy is closely tied with the euro zone so the emerging recession there, which is out of its control, is deeply its problem.

That said, an economy which reaches the giddy heights of carrying total debt five times larger than annual output is one which is largely the author of its own problems.

Cries against austerity are all well and good, but the alternative, more government spending, seems unlikely politically. Britain did well out of debt, financial intermediation and globalization; as those three partly unwind it will continue to do considerably less well.

(James Saft is a Reuters columnist. The opinions expressed are his own) (At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)

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