Are we reaching the tipping point?

Saturday 1st October 2022

Just my two penn’orth, for what its worth.

 

The roots of the current financial situation began to grow long ago but as a starting point, and well within most peoples recent memory, three events have occurred which have compounded the problem.
In 2008 we had the ‘global banking crisis’, beginning with the collapse of Lehmann Brothers in the USA and quickly spreading around the world. Remember those queues outside Northern Rock Bank (formerly a building society) when people rushed to get their savings out as news filtered through that the bank had approached the government for assistance with its liquidity problems. (It had borrowed too much in order to fund mortgages and was at risk of being unable to pay the amounts it had borrowed.)

Northern Rock wasn’t the only commercial bank facing that particular difficulty, all of the familiar banking names up and down our High Streets were in trouble too as a result of their own very risky financial activities. All night meetings took place between bank CEOs, the Treasury, the Bank of England and the then Chancellor, Alastair Darling, to try and resolve the situation.

To cut a long story short, as a result we ended up with the commercial banks being bailed out, thereby avoiding a systemic banking collapse, the introduction of quantitative easing (money printing) by the Bank of England to finance the cost of buying government bonds, interest rates being cut to 1%, thus lowering the cost of borrowing, (savings accounts had even lower rates) and a long period of austerity cuts in an attempt to balance the books.

We all soldiered on but by 2020 these interest rates were still applicable, (good for borrowers but bad for savers) and the debt problem created by all that quantitative easing (money printing) remained.

Then, in 2020, came the next big event, the government’s ‘lockdown’ policy. Remember we had three of those which effectively put the UK economy into several months of idleness. Businesses being closed and employees staying at home resulted in economic inactivity and thus a reduction of the amount of business and personal taxation going into the Treasury.

Not to worry though, good old quantitative easing would save the day so, in addition to all the extra medical paraphernalia expenditure, not to mention paying for all that “NHS’ advertising, that the government had incurred we had furlough payments (paying employees to stay at home), ‘bounce back’ loans to small/medium businesses to help keep them afloat (never mind that many of these were fraudulently obtained and will have to be written off), ‘eat out to help out’ and all the rest of it.

All the while government debt was ratcheting up and now we are currently in hock to the tune of £2.7 trillions worth of gross public debt!

In the late summer and early autumn of 2021 as ‘lockdowns’ were conveniently being ‘memory-holed’ and the country attempted to return to some degree of normality, we had the eye-watering increases in petrol/diesel prices at the filling station pumps, rapidly followed by the arrival through our letter boxes and email inboxes of notifications from our respective energy suppliers regarding the massive increases which would be applicable when the price caps on gas and electricity rates per cubic metre or kilowatt hour were introduced in October of that year, with similar huge increases planned for every three months following. The good news, for the government at least, was that this wouldn’t be funded by even more quantitative easing, oh no, no, no, this comes out of your pockets not theirs. The fact that the government quietly pockets quite a bit of cash from the various taxes levied on petrol, diesel, gas and electricity charges is neither here nor there, that great big debt hole has to be filled somehow, and anyway its all down to market forces mate, nothing we can do about it. After a depressing and futile search around for any cheaper gas/electricity deals 2021 came to a close with most of us having to dig deeper into our collective pockets in a valiant attempt to keep our heads above the waterline as inflation took hold. The Federal Reserve in the USA started to raise interest rates and began monetary tightening so no more money printing. The Bank of England and the European Central Bank began doing likewise.

So we were already in trouble early in the New Year when the next big event came along which was that little local difficulty in Ukraine starting on 24th February 2022.

Regardless of one’s point of view about that conflict it was obvious from the very start that applying sanctions to a country which produces, in abundance, pretty much everything that western countries need to buy in order to simply survive, never mind restart their economic growth after the lockdown disasters of 2020/2021 was not the most intelligent policy to pursue. That particular country has plenty of other customers only too eager to buy its products, it has a budget surplus (unlike ours which has a budget deficit) and its economy is doing very well thank you, although the media would have you believe quite the opposite. Perhaps lying is second nature for them now.

Despite it being a foolish policy that didn’t prevent the then Prime Minister, Eton and Oxford educated Alexander Boris de Pfeffel Johnson, from pursuing and actively encouraging it though. It created a handy scapegoat and blaming the Ukraine situation in general, and ‘Vlad the Bad’ in particular was, and still is a convenient, not to mention a tried and trusted method, of diverting attention away from one’s own, and that of many previous governments, policy failures. It is always easier to blame someone else for your own mistakes. It is foolish to believe that this war in Ukraine is the source of all our financial problems because it isn’t. Cutting your nose off to spite your face in the form of sanctions, not to mention pouring public money into what is reported to be the most corrupt nation on the continent of Europe, has only added to them.

No matter, he’s yesterday’s man now and we have a new ringmistress in charge of the circus, and a new Chancellor of the Exchequer, so everything’s fine now?

Er, well, no, not really, because he’s inherited the debt problems so kindly left to him by his predecessors and in an attempt to get the UK out of the quagmire he managed to land us deeper in the doo-doo.

Before the new Chancellor had even issued his mini-budget statement our new Prime Minister had already announced a two year energy price cap on the afore-mentioned gas and electricity rates. Although those rates would still continue to change, the two year price cap announced by the PM would mean that the government would be paying the excess instead of the customers. That would obviously entail more government borrowing and, of course, at much higher interest rates now.

So along comes the Chancellor a week later and announces that he’s proposing making some tax cuts, i.e. less tax money going into the Treasury’s piggy-bank, but doesn’t address the little matter of the increased government borrowing, mentioned in the preceding paragraph, and how that will be funded. Remember that we are now in monetary tightening mode, quantitative easing is off the table so where will the money for all that two year rate capping come from?

The usual route the government takes is to issue gilts, or gilt edged securities to give them their Sunday name, which tempt buyers by offering good rates of interest over a fixed term. A bit like High Street banks do when they offer better interest rates if you are able to lock away your savings for a two, three or five year term without needing access to it. The longer the term the higher the interest rate on your money will be.

Now who is going to buy those gilts?
Ordinarily it would be large investment houses, insurance companies, pension funds, foreign banks, foreign governments, wealthy private individuals and so on. These individuals know how things stand and how the markets operate so given that they would already know the extent of UK debt, that the interest rate on gilts had already moved higher, that UK growth was sluggish, and that the £ was falling against the $ they would be unlikely to be rushing in to buy. Five or ten years is a big chunk of time to wait to see a return on capital, especially if they are not convinced that the required growth in an economy to provide those promised interest rates is likely to happen within that time frame, and especially one with a weak/falling currency.

In addition to all of the above the Chancellor’s failure to mention how the extra spending would be funded (apparently he’s going to flesh out the details later) only added fuel to the fire so, instead of rushing in to buy more, investors decided to get out while the going was good and made a dash for the exits taking their money with them.

The Bank of England eventually had to step in and buy the gilts to stop the rot/downward spiral and will continue to do so until 14th October. What happens then is anybody’s guess.

The Bank is apparently drawing on ‘new reserves’ to finance its ‘temporary’ gilt buying. Makes one wonder where those ‘new reserves’ have come from, quantitative easing perhaps?

Are we at the tipping point yet?

I couldn’t possibly comment.

*****

If you’re interested in knowing what makes up UK public debt and to whom it is owed this report from the Institute of Chartered Accountants in England and Wales includes a very straightforward and understandable chart together with a short report which is dated 22 September 2022 so before the Chancellor formally announced his mini-budget although the details had been widely circulated beforehand and shouldn’t have taken anyone by surprise – https://www.icaew.com/insights/viewpoints-on-the-news/2022/sept-2022/chart-of-the-week-uk-public-debt

On Monday 3rd October 2022 the Federal Open Markets Committee will hold an extra Closed Board Meeting so it will be interesting to see what comes out of that. Another rise in US interest rates would be certain to be followed by the BoE and the ECB raising their rates too. If the Fed continues raising rates at their next scheduled meeting on 1-2 November 2022 the BoE and ECB will surely follow suit and everyone’s crystal ball is likely to become very cloudy at that point.