Britain, the Canary down the Western Coal Mine

"We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step."

Jim Callaghan - Speech at the Labour Party Conference, 28 September 1976

Gold prices had been on the rise for weeks, then all of a sudden fell back with a thud as we were told that only 11,000 jobs were lost in the US during November. Another Brown bounce in the polls left Cameron backtracking, austerity is so last month, instead 'growth' by government spending is now acceptable as policy is dictated by focus groups. The Middle Easts version of Las Vegas got a helping hand which was good news for many UK banks, however only a mere $80 Billion would have been at stake. Years ago it would have meant something, not today with Trillion dollar bailouts. China's vice governor at the peoples bank declared 'We must watch out for bubbles forming on certain assets, and be careful in those areas' referring to golds recent upward trajectory. Nice try, that deceit may wash with CNBC but those of us in the loop know full well that China would love to transfer much of their paper assets into hard assets such as Gold.

It's sometimes easy to forget what the average person thinks in relation to financial matters. Articles posted here are certainly not consistent with mainstream thinking. People are still on the same broken record, 'Buy a house now while prices are cheap before you get priced out', 'We are past the worst now and good times are ahead', 'The government will make a good profit for the taxpayers with the bank bailouts'. Ask people who read the financial sections of broadsheet newspapers about gold and you get told 'The price can go up as well as down' as though this is a unique quality that does not apply to other assets such as bonds, real estate or stocks. Indeed it is important to remember just what people are thinking, because you don't want to be on the same page as them. 'Repeat after me, Gold is a bubble, Central Banks can 'tame' markets, the sustainable recovery is here and there is no inflation! There is no spoon!' There's no analysis of the thunderstorm that is brewing in the distance.

So what about this Gold bubble then? People are right, however they are 5, 10, 15 years too early in calling it. People are buying the stuff because one day it will be a bubble as the Worlds Central Banks are busy blowing the next bubbles as I write. The currency and Government Bond bubbles will eventually burst causing mass inflation and creating the next bubble, commodities and precious metals. As Bernanke and Company try to assess how best to deal with bubbles, they fool the public as though these events are some mystical force that no one can control. I have a simple solution, how about stop printing so much money. We instead move from bubble to bubble, the Centrals banks policy after one pops is to inject further easy money into the system. Like some drunk who throws up after a bottle of vodka, 'I best have another to sort myself out'.

Could the US unemployment figures signal the turn with people getting back to work? Maybe in the short term, but I don't think this will be a long term trend. You have to remember governments everywhere are printing huge amounts of money and this is bound to give the so called 'prosperity' effect in the short term but it won't last, the free market hasn't healed. During the coming stagflation a lot of conventional indicators will seem to be healing when in fact the underlying fundamentals are deteriorating. For ten years after the credit crunch in 1973/74 the unemployment rate in the UK kept rising.

It didn't move up in a straight line, with periods of consolidation and even movements to the downside. When the correct path was taken it took years to fall. Numbered estimates in the news are useless, three million, four million, all have been given as figures for the short term, however no one can say for certain, all we do know is that history says it will keep rising over the long term.

For a developed country the British people sure do love their inflation. While many other nations inflation indices have plummeting like many a British Banks shares, the UK's inflation rate has remained remarkably 'sticky'. Whether its the appreciation of our assets, our rising incomes, our increased levels of debt or the fallacy that we believe the weak pound is good, we really do want to beat other nations in the race to the bottom. The yanks scream 'bloody murder' watching their beloved dollars debasement from the powers that be, not realising that one hundred years ago a British pound used to be worth $5. Anything you can do across the pond, we can do it much worse. Over the next decade I'm sure we will show the developed world what not to do. The problem I see is that British people want inflation. We want to see rising prices, we believe that this is a healthy state of affairs and will thus allow a greater level of leniency towards our policymakers compared with other nations when it comes to expansive monetary policy.

Will the BoE raise interest rates when the market forces their hand? Contrary to what people believe it is the market that controls long term interest rates. We may like to think of central banks under a paternalistic viewpoint, our saviours there to insulate us from financial destruction and chaos, to solve economic issues should they arise. Central bankers are just like their Communist Central Planning counterparts, eventually market forces get the better of them where eventually they follow the market, not set the tempo as they would have us all believe.

In order to understand how markets dictate prices such as interest rates its easier to compare the lowering of interest rates to say lowering the price of bread. If the government declared rather than liquidity not been easily accessible that the issue was now high bread prices, they therefore set forth a policy to fix the price lowering it below the market one. As suppliers begin making losses they shut down production, at the same time people consume more as they can purchase more of the product. Eventually the country runs out of bread with all stocks depleted. Rather than bite the bullet immediately the government would in all probability resort to rationing rather than admit the error of their ways with bread queues becoming a common occurrence. A black market may appear as people under their free will and against the governments law begin selling bread to one another for a price set by people, the marketplace. If however the government wishes to fix the state of affairs they must liberate the price once more, allowing the market to determine the price of production. As suppliers closed down long ago abandoning their supply networks it takes a short while for supply to meet demand once more. During this period the price of bread goes into the stratosphere as people bid up the cost of the present scarce bread. Eventually market forces will drive the cost down over time to a point of equilibrium.

How does bread relate to interest rates? Its the same principle. Governments can set the price low but eventually the market will force its hand to raise the price, with the price going into the stratosphere. This is why we had 18% interest rates when Thatcher tried to put things right, or when Paul Volker put US rates above 20%. The policy makers were just chasing the market, trying to reign in inflation which was driving the free markets interest rates haywire. During the 1973/74 credit crunch Central Banks had the same idea as now, that is they lowered interest rates in response to the recession, but the longer and lower you try to hold down these prices the higher and sharper they have to eventually rise as many an older reader will painfully remember.

The BoE could be forced to raise interest rates under a number of scenarios. They may have to raise rates if there is a currency crisis with the pound falling as investors flee. Like the bread situation above, they will put off the price liberation, instead they will put currency controls or limits on capital (like bread rationing) in order to try and provide a short term fix. Eventually the market beats them and they have to hike rates as over the long run a lack of foreign investment creates a less dynamic economy and higher inflation.

It could be forced to raise rates if inflation got out of hand with the free market demanding increased real rates of return to negate the depreciation of the currency. Even if central banks keep buying government debt at artificially low rates, private banks still lend to all of us, with this mortgage rates could rise for example. Its similar to what we see now, despite base rates at near zero average mortgage rates are far higher as the free market realises there are inflation risks over the medium to long term. They are also hedging against their potential losses as the government props them up.

However they could do none of the above. They could keep rates low, spurring on more inflation as the government can no longer afford increased rates on the ever expanding debt. They by pass the market and lend to individuals themselves at these rates. They print money directly to cover the shortfall in the various government payrolls. Currency collapse is ensured at this point as it becomes clear to all that its time to pack your suitcase. Marc Faber believes this is the conundrum America will face at some point in which its policymakers will not rise to challenge, instead they will shirk away from the correct action to take, opting for runaway inflation. At some point the stock market of such a country would be a screaming buy, just at the depths of the seemingly never ending hyperinflation when the average person has lost all confidence.

Could the UK be the Canary down the Western coal mine? There are many other nations with serious issues that have faced or will face issues sooner, but I wouldn't put them in the same tier as Britain, a nation who still has a recent innovative and industrious past. She could however, be the warning signal for many other Western nations that mass inflation and/or interest rate rises are just around the corner. Either option ain't pretty.

UK Bubble RIP

"The City of London is pretty much finished ... and if you're alarmed by the recent slump in sterling, you ain't seen nothing yet. In a decade, you're going to be importing oil again - what's going to hold sterling up when you're a net importer of oil? You've already got a balance of trade deficit. I've sold all of my sterling ... there are no fundamentals to support sterling as far as I can see"
Jim Rogers, Chairman Rogers Holdings

"But if investors no longer think the UK's banks are at risk of collapse, they then look at our other vulnerabilities - such as public sector borrowing which is rising very sharply because of the costs of the bank rescues, dwindling tax revenues and the need to spend our way through the economic downturn ... If international investors fear our credit isn't what it was and are selling pounds, we should hardly be surprised."
Robert Preston, BBC Journalist

Since the end of the First World War, Britain had been in a state of terminal decline. Recently, however, the worlds financial markets were loosing confidence in Sterling as the Treasury could no longer balance the books, with ever increasing government spending that could no longer be paid for. By Autumn the pound was plunging, inflation was rampant and the Prime Minister was trying to keep his party together after just recently obtaining the job. The year was 1976. The UK in the end had to go cap in hand to the IMF to avoid economic collapse, the first Western Nation to do so, and only Western nation up until Iceland's recent decline. It ushered in a wave of right wing Thatcherist economic policies which prevailed up until the present day and changed British politics and society forever. The Labour party after the crisis subsequently split between the old left who remained, and the Social Democrats, who later abandoned the Labour party and joined forces with the Liberals to form the Liberal Democrats. Labour also morphed in subsequent years, from the early eighties the 'loony left' politics of Michael Foot, all the way to 'New Labour' a 'Third Way' led by Tony Blair, who won power in 1997 and for the first term emulated Tory spending plans.

Without North Sea Oil and Gas as the seventies came to an end, the UK could have become an economic wreck, and Margret Thatchers monetarist policies in all probability would have failed putting the final nail in the coffin. The UK's trade of balance would have collapsed without the support from the Oil and Gas revenues. In the end, the UK experienced a renaissance and shook itself out of the terminal decline it had found itself in. However in 2008, the UK again showed strains with investors questioning a new generation of Labour Politicians, wondering if history was repeating itself again. Expansive fiscal measures had been announced, with huge government deficits being forecast and the balance of trade in once again, a perilous state. The UK bubble had burst and with it, she resumed her long decline after the illusionary reprieve of the last 25 years.

Over the past 11 years the Labour government has won successive elections, which no other Labour government in history could achieve. Tony Blair won a historic third term and with it, the party had gained the trust of the people regarding economic affairs. It was no surprise that there was a reversal in opinion regarding the economic competence between the Conservatives and Labour which had once favoured the former, now favoured the later. 'New' Labour was nothing more than a Thatcherist project, one that the Iron Lady herself would jokingly remark was her greatest achievement. Labour had increased the Plutocracy that was seen under Thatcher, with little change in the social apparatus of the country. They continued with Tory Policies, such as PFI, the selling of state assets or Privatisation and the push towards the services industry, in particular the over zealous belief in financial services. Yet this 'Third Way' obtained some false perception among the British public, that social responsibility or progress was greatly enhanced under 'New Labour policies', even though it was evidently Thatcherism but under these new false social pretensions. Of course like all socialist governments they were tied to their socialist dogmas, with the incessant need to 'help' people under the guise of the states apparatus. Their spending deficits became more prominent after the honeymoon period, with needless spending and increasing bureaucratic waste. As the global economy began its historic downturn, the government was now exposed for all its true colours. Relative poverty was as bad as ever, hospital deaths from new super bugs had increased with some of the worst standards in Western Europe. The decline in state pensions had not been reversed since Thatcher pegged them to CPI rather than average earnings, which had now become officially the worst in Western Europe. No real social progress had been made, and the economy had become even more imbalanced with government finances in a dire shape with all the one time privatisation cash cows now all but gone. It would soon be 1976 all over again.

So why did the UK have such an extraordinary post 1970's renaissance? The biggest free gift which gave a healthy revenue stream was the North Sea Oil and Gas that had been discovered during the Sixties. This in effect saved the UK from a perilous plight. It enabled Thatcher to follow in the lead of Federal Chairman Paul Volcker and implement Monetarist Policies in order to contract the money supply and cut government spending, suppressing inflation that was causing havoc in the UK's ability to conduct trade. Without the Oil and Gas revenue stream it is very hard to say if she would have been successful, as even with this, there was still huge unemployment and civil unrest. With sound monetary policies Thatcher could then next turn her attention to the Unions who had held successive governments to ransom during the stagflationary seventies. A move towards a more dynamic workforce was critical in positioning Britain for the global challenges that would evolve over the coming decades. The battle against the 'Shock trooper' Union, specifically the miners lead by Arthur Scargill, was subsequently won by Thatcher and meant that the Unions were subdued. The reformation of tax, meant external capital was once again flowing back into Britain, fueling further economic expansion. With tax cuts came the problem of raising sufficient government revenues and Thatchers solution was privatisation, the selling of state assets for dirt cheap prices giving the government a once only large cash flow. Without getting into the flaws or the advantages of privatisation, this is what happened in the UK, but it is a once and once only money machine. The state was slowly selling off its family estate. In 1986 the 'Big Bang' policy deregulated the financial markets and in came the all conquering US Investment Banks, along with further external flows of capital. Thatcher had begun reinvigorating London as the financial center of the World once more, like the bygone age of British hegemony at the turn of the century.

Manufacturing was in solid decline, indeed recession, for the subsequent two decades. The turn towards services was deemed to be Britain's area of strength after the fiasco of Nationalising the Car Industry during the seventies which ended in disaster. An age of retail had begun, consumerism ruled Britannia, with Marks and Spencer becoming the darling of British Retail. Margret Thatcher had a very conservative childhood with strong family values and thrift. Ironically she presided over Britain's largest credit boom of its day, a new consumerism had taken over the nation. Of course all credit induced booms end in bust and this was no different. After unpopular polices such as the Poll tax, and mutiny within the party, Thatcher was ousted and replaced by John Major. As the bust continued Sterling collapsed as it was ejected from the ERM. The subsequent years of 'Tory sleaze' and their old tired public image lead to the publics rediscovery of the opposition. Under Tony Blair Labour had become 'respectable' once more and with amendments to the party manifesto, mainly the abolishment of Clause IV regarding nationalisation, and a pledge not raise income taxes, Labour were voted in on a landslide.

Once in power Labour initially adhered to the policies of Tory tax and spend. They continued with further privatisation of state assets. They ramped up the PFI projects they had once opposed while in opposition, with further increase in off book government debts. During their time North Sea Oil and Gas reached its peak production, with the UK exporting it in ever greater quantities. With the abandonment of Coal during the political clashes of the eighties, the UK drew more of its power now from Gas fired power stations rather than turn to Nuclear options like the French. While in Norway they kept a substantial portion of their Oil and Gas revenues in the Government Pension Fund, for future generations to enjoy and to smooth out the coming decline, Britain in typical Anglo Saxon consumerism spent it all. Debt began its exponential climb upwards as the UK reached its economic peak, as people racked up further debts just at a time the UK would be ill equipped to pay them in the future. More external investors flooded the island with capital, from Russia the Middle East or Asia, London was the nations financial artery, directing more money into a heavy debt laden economy. This further fueled more credit expansion, with the need for less internal savings. The financial liberalisation of the 1980's from the Big Bang came to a pinnacle as British banks expanded more and more, with traditional conservative Building Societies moving into the realm of risk. Northern Rock, with 125% mortgages, or the 'Together Plan', became the dynamic dynamo of London, what would soon be the Enron of the UK.

During this time the Labour government had been increasing spending ever more, running continual budget deficits, with ever more rosy growth projections from the 'prudent' chancellor Gordon Brown. As Oil and Gas production began to decline and with ever increasing reliance on imports, Britains trade of balance deteriorated further. Warning signs were there, but few wanted to acknowledge them. This was after all the new dynamic Britain, who its people believed had become a strong economy with solid foundations. However as the American housing market bubble began to unwind, so did many financial instruments and institutions. Britain had uniquely positioned itself precariously reliant on finance, only Iceland had an even more foolish model. With the global slowdown, came a collapse in the main British Industries, finance, housing and retail. The service economy where we could all become sales people, skills and trades had been outsourced, with everyone getting cuts and no real value being created, was beginning to unwind. Sterling was beginning its decline. Unfunded government borrowing was beginning to occur once more. The UK was not bankrupt, but began on the path towards it.

Just like the seventies where key manufacturing industries were nationalised, the UK government had once again made the same costly errors, this time with the Banking system. RBS, Bradford and Bingley, Northern Rock and further shareholdings in other banks will paralyse the sector for years to come. Without the luxury of being the worlds reserve currency or a major currency such as the Euro, Sterling can't afford to be exposed the way it has. Even with Sterling falling week on week the politicians continue to make more mistakes, recently with the policy of paying the nations mortgages if there is personal loss of income. This will Compound the issues with the battered banks they have nationalised. More money will be needed to pay peoples mortgages and as the banks can't liquidate their assets, will need further government capital injections - a double disaster as the economy tailspins out of control. Indeed, the UK is even beginning on the road to loosing its triple A credit status. It will just be a matter of time before it does. External capital flows are drying up, with Sovereign Wealth Funds questioning their Investment strategy in the once 'dynamic' island. Rather than waiting for the Pound to collapse, Gordon Brown has begun looking for alternatives to try and shelter the UK from the coming decay.

The current government, just like the populace, are in a state of denial. Over optimistic growth forecasts are continually used, with Growth projected to rebound sharply to 2% at the end of 2009. A quite fundamentally flawed figure. I'm not sure the leaders truly appreciate the risks they are currently running with increased government debt, and a further deteriorating economy with no credible plans to reverse these current conditions. The suggestion that they won't be able to balance the books until 2016, shows what a mess we are in, as it uses these optimistic forecasts. With ever decreasing options the Bank of England has begun with suggestions of the nuclear option, namely the printing press, as the options addressed above used by previous governments have all been exhausted. The media are under the illusion a Japan like scenario could occur, however we are not the worlds largest creditor nation like Japan was then, and do not have a trade surplus. Japan tried to inflate like we are now, but failed due to these reasons. We however will succeed and face years of stagflation once again, just like the seventies. The governments are continually propping up the private sector, but no one is asking the real questions. Who will prop up the government? Even mainstream commentators understand the implications, as Robert Preston states just before the Nuclear Option was announced,

"Some analysts see this as the start of the money printing-presses being turned on with a vengeance, a deliberate attempt to stoke up inflation to reduce the real value of all those excess debts. I'm not sure we are there yet - though it's probably only a matter of time."

UK Government debt is set to explode over the next few years, with off book debts being realised as unfunded pension liabilities, Bank Loans, PFI and declining energy revenues further impair Britain's finances. Central Banks and governments have begun explaining the false dangers of deflation, however they know perfectly well they are preparing for inflation, one that will make the seventies mild in comparison. The reduction of interest rates is further evidence of this, by giving no incentives to save, just the further encouragement to spend and upkeep the velocity of money. Victorian thrift has long gone.

Of course there are no economic fundamentals to support the UK, as the quote at the start states. All of the above, PFI, nationalised finance, unfunded government spending, privatisation, pension liabilities and off book debts, will now go into reverse. Just as they exacerbated the boom on the way up, they will exacerbate the bust on the way down, all compounding with one another over the coming decade.

However, when history is examined Britain has a long and successful functioning liberal democratic system, one that was able to survive the excessive debts obtained during the wars with France, and with it rose as the global power. With debts in excess of 200% of GDP, the UK did not default like many other nations did. It instead paid all the bond holders even in a period of extraordinary deflation during the pioneering phase of the Industrial Revolution. She rose to become the greatest creditor nation the world had seen, spearheading what we now associate as modernity. As Europe succumbed to Fascism during the crisis in capitalism throughout the 1930's, Britain maintained its traditional liberal democracy. These historical factors alone won't prevent the decline of Britain. It involves a painful transitionary period, which politicians are notorious for preventing. Even with this there are no guarantee's as Britain is not what it once was in 1815 and the world is a much different place. We may have seen a high in the UK in our lifetimes. We may be witnessing the beginning of terminal decline.