How long can the UK keep running its Balance of Payments deficit?

The recent period of expansion has been very welcome for the UK economy but it has come with a handicap which is familiar to students of UK economic history. However general analysis of the situation is very different to the past and a considerable amount of complacency is displayed. But even the Bank of England has its concerns. From the latest Financial Policy Committee Minutes.

The Committee discussed the potential risks relating to the UK current account deficit position. The current account deficit had widened to 6% of GDP in Q3 2014 which was high by historical standards in the United Kingdom and elsewhere.

They then spend some time concluding that this is really okay (which if so begs the question of why they raised the matter!) After all does anybody actually believe the hype in the sentence below.

Moreover, to the extent that fiscal policy was credible and investors were confident in the monetary and fiscal policy frameworks and the United Kingdom’s continuing openness, current account deficits would be easier to finance.

In the current election debate I have mostly only seen incredible efforts on fiscal policy and monetary policy is still at the emergency Base Rate of 0.5%. Oh well. the result of all of this was the classic bureaucrats solution.

The Committee agreed to keep their assessment of this risk under close review and would monitor the maturity and liquidity of the financing of the deficit

Should the horse ever bolt they will be there to close the stable doors afterwards!

Step Back In Time

If we go back to 1967 then things were very different as in November the UK government devalued the exchange rate of the UK Pound £ from US $2.80 to US $2.40 in response to a balance of payments crisis. You may have a wry smile at the numbers involved. From The Sterling Devaluation of 1967.

That deficit was estimated at the time to be approaching £800m, but later revised down to nearer £300m.

Of course our minds have been distorted by the financial inflation of these times so let me convert the numbers for you as the panic of the times was caused by a current account deficit of around 2% of annual economic output or GDP. Putting that another way it was somewhere around a third of the number being discussed by the FPC.

There are of course differences as a fixed exchange rate puts more pressure on such matters as those in the Euro area and of course Denmark and Switzerland have discovered in recent times. But you see here we have something of a (space) oddity as the present UK balance of payments problem has been accompanied by a rising exchange rate for the pound. Since the recent nadir of March 2013 the trade weighted index has risen from 77.9 to 90. So one more time we need to tear a page out of economic textbooks. Or to put it another way it would not be the best of times to ask HAL 9000 to open the pod doors if you were out in space!

Also you may note another feature of balance of payments numbers which is their inaccuracy. Due to later revisions which were years and sometimes decades in the making it was discovered that the 1967 Sterling Devaluation one of main symbolic points in UK economic history was unnecessary. As the Rolling Stones put it so aptly about accurate economic statistics at around that time.

You can’t always get what you want
You can’t always get what you want

 

Today’s Numbers

We get an idea of the position in the early part of 2015 from this.

Seasonally adjusted, the UK’s deficit on trade in goods and services was estimated to have been £2.9 billion in February 2015, compared with £1.5 billion in January 2015. This reflects a deficit of £10.3 billion on goods, partially offset by an estimated surplus of £7.5 billion on services.

So a more hopeful picture for January seems to have been replaced by a same as it ever was February. Even the more hopeful picture involved a deficit as it is quite some time since we had a surplus of any sort. Also the January numbers had a familiar feature.

The total trade balance in January was revised downwards by £0.9 billion from the January 2015 UK Trade release

So not only are the numbers unreliable it is good news that is particularly so. This leaves us with a continuing issue.

In the 3 months to February 2015, the trade in goods deficit narrowed by £0.1 billion to £29.4 billion.

Also those who argue for trade benefits from our membership of the European Union would do well to mull the number below.

In the 3 months to February 2015, the trade in goods deficit between the UK and countries within the EU reached a record high of £21.1 billion, since comparable records began in 1998.

A little care is needed as we have a surplus for services but the position above is dire.

Is there any hope?

There is a thematic hope for the UK economy and it comes from the services sector where we put in a strong performance as shown below.

The surplus on trade in services was estimated to be £7.5 billion in February 2015.

Somewhat bizarrely the actual number is £7481 million. Why is this bizarre? Well actually they have nothing like this level of accuracy as they confess here.

However, the information on trade in services is
mainly obtained from quarterly surveys, in some cases underpinned by larger annual surveys. That means that the data for the latest months are inevitably uncertain.

A cursory examination of the one page of detail we get on services trade would miss that as would anybody who looks at numbers measured to £1 million. I analysed this issue in reference to the UK “productivity puzzle” on the second of this month and concluded that we need to get more accurate numbers for this area as our view of our economy could be transformed and would as a minimum be more reliable. After all we do live in an information age don’t we?

But the picture such as we have it is of an improving position illustrated by our services surplus being revised up by around 10% on a year ago.

Also the lower oil price is helping us as whilst we produce oil we are a net importer. Although if today’s news from UK Oil & Gas Investments Ltd comes to fruition maybe….

London quoted UK Oil & Gas Investments PLC (LSE AIM: UKOG) is pleased to announce that US-based Nutech Ltd (“Nutech”), one of the world’s leading companies in petrophysical analysis and reservoir intelligence, estimate that the Horse Hill-1 (“HH-1”) well in the Weald Basin has a total oil in place (“OIP”) of 158 million barrels (“MMBO”) per square mile,

Of course they will only be able to get to a relatively small proportion of that and such announcements are prone to what I shall politely call hype but it could be a bonus.

Comment

The complacency over the UK Balance of Payments has partly been driven by the fact that we have been numbed by year after year of deficits. So there is a natural tendency to assume that the problem does not matter. What could go wrong? Well this as I pointed out on the 2nd of this month.

In 2014, the UK’s current account deficit was £97.9 billion, up from a deficit of £76.7 billion in 2013. The deficit in 2014 equated to 5.5% of GDP at current market prices. This was the largest annual deficit as a percentage of GDP at current market prices since annual records began in 1948.

A factor here was a decline in our net international investment position partly created by the years of other deficits. There are flickers of hope for marginal improvements so far in 2015 but of course the numbers are unreliable. I also believe as I wrote on the 2nd of this month that we underestimate our services performance but if this was a bomb it is ticking albeit apparently slowly.

On the subject of the strength of the UK Pound I wonder how much of that has been driven by demand for UK assets such as property from abroad. In the vast sums of foreign exchange it may seem small but at the margin such things matter. Perhaps our greatest economic success of these times will be considered to be the sale of overvalued houses to foreigners!

You’re Unbelievable

I was reminded of this from EMF when I read this and in case you do not know he is the Governor of the Central Bank of Ireland.

@INETeconomics Direct bailout of the banks has been relatively small say @PatrickHonohan

 

I guess “relatively small” goes into my financial lexicon for these times.