Could England be headed for a “sudden stop?”

November 21, 2009

From Landon Thomas at NYT: In Britain, visions of Japan’s decade of stagnation

Britain may finally be emerging from recession, but many analysts warn that it is a false dawn. In fact, they argue, the economy here is so ravaged by growing debts and ruined banks that it could well be following in the steps of Japan’s lost decade of the 1990s.

I still don’t understand why we refer to Japan’s “lost decade,” singular. The country is now moving into its third consecutive lost decade.The Nikkei is still at 1984 levels.

But back to the UK: the NYT piece quotes the latest research from Variant Perception (no link). I got it in my inbox earlier this week and it’s a fascinating (though not pleasant) read. Notably, they talk about the outside possibility of a “sudden stop” event. As mentioned in this space before, a “sudden stop” is what happens to emerging economies when they lose access to capital markets. Confidence is lost in the government’s ability to pay back debt and everyone races to get out of the system. See Argentina.

The problem is acute for indebted emerging markets because they don’t borrow in a currency they can print. So, the argument goes, you can’t have a sudden stop in Britain, or the US, because we print the currency in which our debt is payable.

I’ll let the VP guys take it from here:

The UK’s fiscal situation is in its most precarious state for 30 years. The Bank of England has responded by cutting rates to historic lows. This has merely bought time. Debt in the household sector remains at its highs, and enormous relief has been provided to many overleveraged mortgage holders who hold tracker deals [i.e. teaser-rate mortgages]. They have been able to ride out the recession so far without defaulting. As their trackers expire and they reset to higher rates they will face acute problems.

Usually a government can quickly return to fiscal vitality after a cyclical upturn. The UK will find this difficult. Structural problems such as a heavy reliance on the business and finance sectors and a consumer that will eventually have to deleverage will provide strong headwinds to any sharp turnaround in revenues.

To pay for the shortfall in income, the UK government has stepped up bond issuance to generational highs. This is not sustainable and taxes will eventually have to rise. However, there is a belief that raising taxes will increase revenue. We believe the opposite is true, and the state will have to borrow more than is projected, for longer than is hoped.

The Bank of England has embarked upon a quantitative easing program to support the gilt market. The sheer size of the initiative raises the question of whether it will be able to reverse it in a stable and orderly manner. Any trip-ups in its unwind would raise yields considerably.

The structural problems in the domestic economy, and difficulties in other economies across the globe, will impede the prospects for sustainable growth in the UK. Debt will continue to grow, and the creditworthiness of the country will continue to weaken. Investors will be more and more reluctant to meet the borrowing needs of the UK.

If the situation continues to deteriorate there is a non-negligible possibility the UK could face a ‘sudden stop’ in capital inflows. A debt crisis would precipitate a currency crisis. This would not be especially unusual for the UK: during the postwar period, there has been one on average every 15 years. These have happened like clockwork.

The possibility of this course of events unfolding is small, but not negligible. If a new government is formed next year, perhaps they will be able to enact the policies that will reduce the deficit and restore confidence in the financers of the UK deficit. We believe, though, that to say the UK will not have a debt crisis is complacent and pays no heed to the past.

If Britain is laid low by a sudden stop event, if the BOE finds itself the only buyer of British government debt, the argument in favor of deficit spending whenever there’s an “output gap” will, in my view, suffer a fatal blow.

Also worth calling out, the VP guys note that household debt is still growing quickly in the UK:


In order to return to health the UK, more than most countries, needs to deleverage. However, this process still seems to be in its early stages. UK consumers have so far not materially improved their balance sheets since the onset of the crisis. This is concerning: before the crisis, UK consumers were some of the most indebted in the world, and so have more urgency than most to reduce their indebtedness via deleveraging or default.

But …. household debt to GDP in the UK continues to rise. This is partly a denominator effect, as nominal GDP has fallen in the recession. However, even on a QoQ basis, household debt has barely contracted.

The US consumer, by comparison, is showing much clearer signs of reducing leverage. Over the last 2 years (to Q209), US household debt to GDP has risen by 0.7%-pts, while in the UK the same metric has risen by 4.4%-pts, more than 6 times as much.


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I find variant perception to be very accurate and timely information..pls keep ip the good work..question still remain in the household debt to GDP and whether anything in the earopean /UK can be sustained ..I believe the situation becomes very dire in 3 yrs out or more based upon their current path…

Posted by globalguy | Report as abusive

Substitute U.S. for U.K. and Treasuries for Gilts and the piece places well on the other side of the pond.

Posted by JMKeynes | Report as abusive

‘England’!!!!What is this – like, the 1930s or something.Britain or UK thanks.

Posted by Jo | Report as abusive

Excellent post.One of the big developed economies will have to have a major debt crisis to knock some sense into the others.We draw way too much comfort from Japan, which “proves” that government debt can be handled at much higher levels. It is kind of a fluke of history that they have been able to run such huge deficits for so long without inflation. They have been uniquely awesome exporters pouring world class products into a massively growing world economy. The car is to exporting as the 100m dash is to sport, a pure test of prowess attempted by all the big economies, and they have been the best.

Posted by Dan Hess | Report as abusive

An excellent post and a more excellent reply. Goodbye, Britain, and America, good luck.

Posted by Jeffrey | Report as abusive

The Japanese are savers and the govt merely borrows from its own citizens, not Arabs, or Russians, or Pakistanis who have enormous sterling denominated savings parked in UK banks… Japan needs to “raise rates” in order to persuade its citizens to spend, rather than save.. BUT convincing “ivory tower academics” of this solution is futile… As for the UK, I for one am betting against the pound, expecting to repeat “Soros run” of 1992… While GBP/USD has been stubbornly rallying around the 1.65 level with support from Barclays etal.. I doubt if such efforts are sustainable as the “tax man” drives ever increasing “non-Brits” to slowly withdraw and park their moneys elsewhere..

Posted by pravin | Report as abusive

It is also plausable that the UK is trying to ease the resistance to their exports by cyclical publication of recurrent bad news. This would, they hope, to weaken the sterling and enhance exports.

Posted by H Hashimi | Report as abusive

Just a couple of thoughts. Yes, Gordon Brown has destroyed British finances but unemployment is lower in the UK than in the US ( though that might be in large part to Brown’s expansion of public sector employment) and the pound has fallen significantly in relation to the Euro ( again due to Brown’s spendthrift ways). Still, because of the falling pound, some European manufacturers are shifting their production into the UK from European plants so remaining outside the Eurozone does have some advantages for the UK that Ireland or Spain, e.g. do not have.The interesting thing we may see resolved by the UK’s problems is whether QE and massive fiscal deficits lead to inflation or deflation. Liam Halligan and Ambrose Evans- Pritchard at the Telegraph make convincing cases for either outcome and, as the UK’s situation mirrors that of the US in many ways, seeing which way it breaks there will be likely show our own fate.

Posted by sangellone | Report as abusive

And there’s this:Swiss personal tax rates are as low as 20pc and there have been reports of UK-based executives being offered a 10pc tax rate as the government steps up its drive to entice high earners e/newsbysector/constructionandproperty/6 624407/High-taxed-City-workers-looks-to- the-Alps.html

Posted by Mark G. | Report as abusive

That is one possibility. However, the fiscal policies of the UK is far stronger in a country of 65 million. On the other hand the Uk has a tendency to throw somewhat bad news in a cyclic manner to adjust the currancy exchange rate in a way to enhance their exports. this is seen every time the Sterling exhibits a tendency to climb above expectations, which helps the UK ride any fiscal crisis in a resilient manner. Note also that the biggest European banks are UK based (HSBC & Barclays). They were allowed to refuse government aid & to indulge themselves and diversify with the help of cheap & endless Middle Eastern funds, a very clever lateral thinking in the midst of the global crisis. The US however, adopted a too little too late policy.

Posted by H Hashimi | Report as abusive

It is still the same thing happening over and over. A country can only create wealth when people own properties and businesses without having large debts and mortgages. These businesses must also produce products that benefit people. To keep people in debt has never worked for any country. Yes, it keeps the company store going and keeps a few people rich, but that does not work either. You cannot have growth with heavy debts and poor people.The strength of the United States was built because people were able to grow businesses. Recently we have lost our way due to poor teaching in our colleges and universities and poor government decisions.

Posted by f belz | Report as abusive

Two observations:1) Sadly, you don’t quote the sources for your debt graph. The BBC have been fairly regularly reporting on the extent to which households *are* paying down debt. So it seems reasonable to assume that there are some measures by which it is decreasing and some by which it isn’t, with journalists picking whichever figure supports the chosen angle of their story.2) Those tracker mortgages are good news – they don’t all reset at once (which would indeed be a “sudden stop”) but will naturally reset in a staggered fashion over a few years (ideally leading to a “soft landing” slowdown in household expenditure).

Posted by Ian Kemmish | Report as abusive

Broader Measure of U.S. Unemployment Stands at 17.5%DAVID LEONHARDTPublished: November 6, 2009For all the pain caused by the Great Recession, the job market still was not in as bad shape as it had been during the depths of the early 1980s recession — until now.With the release of the jobs report on Friday, the broadest measure of unemployment and underemployment tracked by the Labor Department has reached its highest level in decades. If statistics went back so far, the measure would almost certainly be at its highest level since the Great Depression.In all, more than one out of every six workers — 17.5 percent — were unemployed or underemployed in October. The previous recorded high was 17.1 percent, in December 1982.TELEGRAPH and climbing: the real unemployment tollBy Edmund ConwayThe labour market figures published this morning were pretty encouraging, showing that the the number of people out of work is, if not falling precipitously, then at least rising far more slowly than previously. Indeed, look beneath the headline figures which showed a 30,000 increase in the number of people out of work between July and September to 2.46m and you can see broad based signs of improvement.But it is important not to lose sight of the scale of the problem. Weve all heard plenty about the youth unemployment issue (rising to around 20pc of people under 25 now) but the problem is far broader than that. In my column a few weeks ago I mentioned that if you add up all the people who would like to work but for various reasons cant get hold of a job (something Chris Dillow looked at last month), you actually get the rather more alarming unemployment figure of 5.6m.The latest figures show that this is now closer to 5.7m, (over 15pc of the working age workforce) and is reaching the peaks it hit in the early 1990s. To clarify, this measure of unemployment includes: official unemployment, those classed as economically inactive who actually want a job and part time workers who would rather be working full time. Here is a chart showing you just how sharp the increase in this category has been over the past year or so.

Posted by Michael Moore | Report as abusive

Ian….here’s a line from the VP report that may help explain the difference:”New consumer lending in the UK continues to contract at a rapid click, reflecting a reluctance from overleveraged consumers to borrow (as well as a preference from chastened banks not to lend). Consumer debt, however, is only 15% of household debt.”

Posted by Rolfe Winkler | Report as abusive

One reason that the UK consumer has not begun to deleverage is that unemployment is not as high as in the US. Also, since the “safety net” has more and denser webing than in the US there is less incentive to do so.

Posted by Bob4232 | Report as abusive