- Britain’s economic crisis is a warning to the world.
- It is also a sign of a failed fiscal orthodoxy.
- Leaving EU membership has little to do with it.
Falling exchange rate and rising bond yields are the typical characteristics of a financial crisis in an emerging market. Those who never forgave the UK for its decision to leave the EU like to remind us of this fact right now. But an emerging market crisis doesn’t even begin to capture what is going on. It is a macro financial crisis story, EU membership is not the issue here.
Pound Takes a Pounding
Broad macro crises always start somewhere. The Asian financial crisis started in Thailand. The euro area’s sovereign debt crisis was triggered by an excessive deficit in Greece, but it spread to countries like Spain that observed fiscal rules. The global financial crisis was triggered by lending practices in the US housing market and it spread to the global banking system. If you think that this is about Brexit, you could not be more wrong.
The UK’s budget was the fiscal expansion too far. The strategy was clearly risky, but what wasn’t clear was that the risks would become so evident so quickly. There are vulnerable spots in the euro area too. France’s overall financial position is not all that different from the UK’s. France has a slightly higher debt-to-GDP ratio than the UK. France and the UK have roughly similar current account deficits. The projected UK budget deficit for the current financial year is around 8 percent of GDP. The French government just came out with a 5 per cent budget proposal that could inflate even further. The pound lost heavily against the dollar. This is more of a story about the dollar than about the British economy.
The Road Downhill
The real issue for the UK economy is the interest rate. For starters, a lot of UK business models rely on low interest rates. The housing market has been supported by buy-to-rent schemes, which have ceased to become viable overnight. House prices in some areas have doubled as a result of the Airbnb boom. With base and mortgage rates at a predicted 6 per cent, expect a lot of forced sellers trying to offload their debt burden. Many families will struggle with mortgage payments, a financial shock that is comparatively larger for them than the electricity price shock. Some UK mortgage lenders lent out mortgages at five to seven times annual income, mostly to young people on a first-time mortgage. Many of these young first-time buyers will be financially wiped out once their fixed-term mortgage comes to an end.
The real danger is that cornered governments pile bad policies on existing bad policies. Companies need to be assisted by facilitating immigration, lower bureaucratic thresholds and minimum salary hurdles. Labour supply is where Brexit is doing real structural damage. This is not the cause of this crisis, but an unnecessary burden. The current government still has two years until the next elections. This is still very much mid-term. History suggests that electorates switch parties during financial crises – the UK in 1979, US in 1992 and 2000 etc. For the Conservatives, what is going on right now is existential.
Did you subscribe to our daily newsletter?
It’s Free! Click here to Subscribe!