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Thursday, November 13, 2008


anarchy in the uk?

since discussing the krona carry trade back in 2006, i've mentioned in passing the debacle in iceland, which some have said could represent a model for the eventual failure of other, larger nations -- one of which is britain, which shares many common features with iceland but on a larger absolute and smaller relative scale. indeed, the collapse of iceland fed directly into their difficulties, as many britons -- corporately and individually -- played the carry trade by depositing funds in now-failed icelandic banks.

in recent days, however, symbiosis has given way to a level of imitation as the pound has collapsed precipitously and the economy tanks with frightening speed.

now mish passes on the bleak assessment of former tory chancellor ken clarke -- the UK is on the brink of meltdown.

Mr Clarke, 68, said the British economy is headed for a "catastrophic crisis" that will be "far worse than anything that has occurred in my lifetime".

"There will be a very serious recession next year," he said in an interview with Telegraph TV. "I think the big problem in 2009 will be the catastrophic fall in consumer spending demand, spending in shops will get worse."

note clarke's concern with the level of public expenses.

the telegraph's ambrose evans-pritchard sounds the klaxon on UK deflation, noting rightly how much more destructive it can be in our high-debt environment than it was in the relatively lower-debt 1930s, and how the liquidity trap the anglophone world is in may be quite hard to break.

Nor is it clear whether rate cuts are gaining much traction. The average rate of tracker mortgages has risen 72 basis points since last month, and credit card rates have been rocketing. The Bank's transmission mechanism is not working properly. This a variant of the 1930s struggle when the central banks found themselves "pushing on a string", in the words of John Maynard Keynes. He called for public works to lift the economy out of its liquidity trap. This is more or less what the US, Japan, China, and parts of Europe are now doing – with more in store after the G20 this weekend. Britain has pitifully limited scope on this front. We had a budget deficit of 3pc of GDP at the top of the cycle – when we should have been in surplus – and we are heading for over 8pc. This is already nearing the danger level. If the Government now lets rip on fiscal policy, we could face a 'gilts strike' as foreign investors retreat from UK debt.

The Bank of England has not run out of ammo yet. It can cut rates to zero if necessary and then escalate to direct infusions of money by purchasing bonds – or indeed by buying a vast range of securities, assets and even houses if necessary. Ultimately it can print money to cover the budget deficit.

As the late Milton Friedman put it, governments can drop bundles of banknotes from helicopters. If they really want to defeat to deflation, they can. Mr Friedman may have overlooked the fact that gunmen can shoot down the helicopter – the Bank of France in October 1931, when it ditched the dollar; perhaps Asian bond investors today? – but that is to quibble.

a buyers strike against government debt and the local currency is exactly what iceland faces.

it's very hard to make the conceptual leap from the collapse of a ridiculously overobligated nation smaller than the city of milwaukee to the somewhat-less-ridiculously overobligated united states. but the leap from britain to the united states is not so hard to imagine; nor the leap from iceland to britain. there are of course important differences -- not the least of which is the united states as the source of both the global reserve currency and much low-interest-rate carry trade funding. but if iceland was the canary in the coalmine, britain may be the collier standing next to us.

UPDATE: willem buiter with more on the similarities between iceland and britain.

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I like your blog. I don't believe the dollar will remain the World Reserve Currency. More financial big shots speculate over a US Default daily.

Jim Willie suggests: "that the Europeans, Russians, Chinese and Arabs, have agreed to a new world currency. It’s going to be based on a basket and the dollar and British Pound are not included. Those currencies are going to be largely tethered to gold. There’s going to be a new Russian gold-backed Rubel and a new Arab-Gulf Dinar. You cannot have a global finance system with a world reserve currency based on a debt system or an indebted economy…you have to ask yourself who is calling the shots, who is forcing decisions? The answer is the Bank for International Settlements which has had enough of the United States.”

We shall see.

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from perrone: but we could look at that from a different angle, gm, which I think might be more pertinent. instead of saying "we're next," you could think "holy shit, when this is all over, we'll be the only ones left standing."

more clearly than ever now, we see that "decoupling" was a ridiculously misconceived notion. the U.S. is the largest, most influential economic player and remains at the center of the world economy. it not only buys from everybody, it sells a lot, too. its real assets, which are immense, are both tangible and intangible. whatever theoretical ("classic") weaknesses it is perceived to be succumbing to, these must be evaluated within the context of a severely imbalanced world economy. a surplus can be as noxious as a deficit, just ask Japan. the inevitable and irrevocable rebalancing of the world economy, while painful all around, must needs be less dislocating towards the center and more dislocating towards the periphery. the short version: everybody else -- including China, (no matter how big its sovereign wealth fund is) where instituions are rigid and not robustly legitimate, and where half a billion people make less than 10 bucks a day -- may very well be worse off than we are.

does this construct make sense?

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