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Sheldon Filger

Sheldon Filger

Posted: March 15, 2010 09:53 AM

UK Economic and Debt Crisis Approaches Dangerous Tipping Point

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Amid the clamour over the Greek debt crisis, a far more perilous threat to the global economy is becoming increasingly apparent. The global economic and financial crisis has wreaked havoc on the United Kingdom's public finances, with no clear path to salvation.

Consider the following statistics. Greece has a GDP of approximately $350 billion, compared with $2.2 trillion for the UK. In other words, the Greek economy is only 16% the aggregate size of Great Britain's. The proportion of Greece's annual deficit to GDP is 12.5%, a figure that has triggered the current Greek sovereign debt crisis and panic search for a bailout formula within the Eurozone. Yet, in the much larger UK economy, the deficit to GDP ratio has reached 13%, an even higher level than for Greece, which has aroused so much fear among global investors and policymakers. Furthermore, while the UK's official public national debt comprises 68% of GDP, a figure lower than America's and much lower than with Greece, that level of indebtedness is accelerating at a rapid rate. It must be recalled that only three years ago the UK national debt to GDP ratio was only 38%, and with double digit deficits now an inescapable fiscal reality in the United Kingdom, it seems almost certain that the nation's public debt will exceed 100% of GDP within the next three years. Furthermore, it is widely believed by analysts and investors that off balance sheet public debts (as was similarly revealed in relation to Greece's current debt crisis) and unfunded contingent liabilities significantly add to the official figures.

What do these dismal statistics tell us about the future trajectory of the UK's profound sovereign debt and economic crisis? Consider what Kornelius Purps, fixed income director at UniCredit, Europe's 2nd largest bank, told the British newspaper,The Daily Telegraph; "Britain's AAA-rating is highly at risk. The budget deficit is huge at 13% of GDP and investors are not happy. The outgoing government is inactive due to the election. There will have to be absolute cuts in public salaries or pay, but nobody is talking about that."

In effect, the UK economy is at a dangerous tipping point. Massive public indebtedness occurred as a result of the government's bailout of its banks, yet businesses remain afflicted by a severe credit crunch. Massive stimulus spending has added enormously to the deficit, but the only result has been suspect figures that, if interpreted most optimistically, show that the UK's economy has essentially flatlined after incurring a sharp contraction in economic output during the height of the global financial crisis.

The predictable outcome, as alluded to by Kornelius Purps, is that in the future the UK's treasury gilts will be unable to finance the nation's prodigious borrowing needs with historically low interest rates. At some point, perhaps sooner than many realize, interest rates on the UK's debt instruments will rise precipitously. This will occur while GDP growth is at best sluggish. Sharp reductions in public spending will almost certainly tip the economy back into deep recession, further constricting revenue and maintaining London's fiscal imbalance. However, the alternative is even more unpalatable. The sovereign bond market will demand increasingly higher yields, leading to a fiscal reality that is unsustainable. Ultimately, the United Kingdom will face the real prospect of national insolvency, with all the predictable dire consequences.

This grim trajectory has an even darker meaning for the United States. As bad as the UK's fiscal situation is, America's is far worse. Its annual deficit to GDP ratio is only marginally lower than Great Britain's. Furthermore, its national debt to GDP correlation is significantly higher. More importantly, the average period of turnover on the United Kingdom's debt is 14 years, compared with a mere four years on U.S. Treasuries. Once bond yields start to rise, the short term structure of America's national debt will incur a vast increase in annual interest payments.

It seems to this observer that it is only a matter of time before the UK sinks into an irreversible sovereign debt cataclysm, with the United States not far behind. Anyone who believes that the same political establishment and financial elites that have led both nations to this hellish fiscal precipice can now lead us to a sustainable solution is, in all probability, being excessively hopeful.

 
 
 

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