not born yesterday beady eye

Just nine months ago, Gordon Brown was painting a rosy economic picture as the lead-in to an election he now claims was never on the cards. When the Northern Rock collapse removed his electoral window (and gave the lie to his 'forecast' of strong economic growth) the Government underwrote around £139 billion of potential liabilities at the Bank.

Since then, the two further banks targeted by nby as very unsafe - Bradford & Bingley and Alliance & Leicester - have respectively become insolvent and been sold at a knock-down price. Three months ago (see When the Money Runs Out) we raised the issue of a British Government swamped by commitments and unable to meet its liabilities.

Today we reveal how - even in the time since that piece - such an outcome has moved from highly unlikely to disturbingly possible.

As each month progresses, more and more balm is applied to the anxieties of the British electorate by a Government whose previous protestations of 'everything being perfectly alright' seem - in a ghastly parallel development - to be more and more unreliable.

The reality of the inexperience and ineptitude of the two key figures closest to this rapidly emerging unexploded bomb gives little or no comfort to the worried investor. Ten years ago next Spring, the sitting Prime Minister sold 50% of Britain's total Gold reserves at the ludicrous price of £281.50 an ounce. Not only did Treasury and Bank officials vehemently oppose the sale in writing, they also warned Gordon Brown and his coterie of the insane naivety of flagging the sale in advance via an auction - for this would (and did) depress the price, as speculators waited eagerly for the baby and his candy.

Brown's circle tried by every legal means possible to delay publication of the strongly contrary advice offered by their officials....by which time the world had moved on, and an electorate still enjoying the boom that would never bust lost interest. By the time the five auctions had taken place (actually disposing of 400 tons - nearer to 60% of the reserves) Britain found itself with less Gold than any other developed nation. Germany now has seven times more, France eight times our piddling 310 tons. The UK's gold stockpile, at just £9 billion, is more of a pimple than a mountain.

The man Gordon Brown chose as his successor (a pliant and largely dull Scottish lawyer) was not entirely prepared for the Northern Rock crisis. Although the Prime Minister knew the Bank was in difficulties, his Chancellor found out some time later from three senior Treasury officials. His face a picture of bland astonishment, Alistair Darling's first question was "What do you normally do in these circumstances?" The officials politely pointed out that this was the first run on a bank for over two centuries.

Darling continues - like his boss - to insist that Britain is 'better equipped' than other G8 nations to 'weather the slow-down' - a decelaration that almost every other commentator is now calling a recession, and nby continues to depict as a full-blown depression. There are many, many forms of financial data freely available to show that Darling's prognosis is a fantasy - Britain's astronomical personal debt and growing national foreign currency commitments for starters - but above all, the chief fly in the Chancellor's ointment is Gold - or rather, our lack of it.

The US Federal Chief Ben Benanke (not a man prone to overstatement) said only last year, "When the chips are down in international debt conciliation, Gold is the only acceptable form of currency". His predecessor Alan Greenspan - along with every other EU Finance Minister and the EU's Central bankers - expressed surprise at Britain's 1999 gold auctions; the American in particular said "no country of which I'm aware has plans to sell gold". The unspoken rhetorical question was "And why on earth would they?"

In the context of international debt settlement, assets other than gold are merely numbers on a balance sheet: a major creditor is unlikely to accept the Humber Bridge in part-payment. What makes this issue terrifyingly more than academic is the size of Britain's international financial commitments.

The one-sentence summary to hold onto here is that our Government is up to two trillion dollars in debt, and has just nine billion dollars in gold.

While it is relatively easy to get to the basic facts about Britain's p & l account, the balance sheet - with all of its multi-layered forms of asset/liability mix and classically obscure audit terminology - is something of a smoke and mirrors job. Frequently (and at a level of dissembling that beggars belief) government ministers hide, dilute, underestimate and generally fudge the seriousness of our financial position. The original intention to sell gold, for instance, was slipped quietly into a 90% empty Commons Chamber by Tricia Hewitt (who else?) and then blown up in Dayglo onto a barrage balloon for the market - proving beyond doubt that the term 'naive cunning' need not be an oxymoron.

We mention this here as the counter-argument to any reader who finds our suspicions about subterfuge a little farfetched. Here are the basic facts, minus any hastily applied coats of varnish.

Britain's population stands at just over sixty million, and the liabilities of our Government represent exactly £58,000 for every man woman and child in the country. Although keen to show our debt as a proportion of the one trillion dollar Gross Domestic Product (Britain's total per annum wealth output) this is inappropriate when one considers that the Government takes just eight hundred billion of that in tax revenue. (Almost 12% of that total last year was mortgaged to the liabilities of just the one Northern Rock Bank.)

Including gold, we have $23.6 billion in reserves as a Government. On this same basis, we have current liabilities of slightly more than this. The italics are used there to highlight something of a shift in accounting since 2001. The change has been simple and yet significant - much of the debt has been shuffled over to the Bank of England.

To put this into some kind of historical perspective, in August 2000 the Old Lady's accounts showed a trifling £8.3 billion of foreign currency liabilities. By December 2007, this figure had mysteriously climbed to £40.3 billion - while the Government's debts fell accordingly. (Bear in mind also that at the start of this period, we had made £11 billion on gold sales. I urge you to follow in my footsteps and try to discover the whereabouts of the gold-auction proceeds today).

The accounting tactic had the obvious advantage of allowing Brown to suggest that the country's debts were falling - although to be fair, the man is such an obfuscator on so many levels, he never had to do this overtly. However, a man who depicted an abolished low-tax band as a tax cut would, we can rest assured, have pulled this wool over the eyes too had the Devil of circumstances driven him at any point so to do.

At some juncture between December 2007 and February 2008, Bank of England Chief Mervyn King became convinced that not only was the 'credit crunch' far from over, it was almost certainly about to be exacerbated by other increasingly obvious signs of a global economic (as well as financial) malady.

In private, King had for some time taken a far more pessimistic view of the medium-term future than either Darling or Brown. When banking problems first emerged he was loath to reduce interest rates (he continues to maintain, like nby, that reduced rates and pumped cash will not save a cracked dam) but although ruthlessly fingered by the two politicians as 'to blame' for delaying interest cuts and thus deepening the crisis, the Bank's Director played his cards skilfully, thus ensuring the eventual reappointment for a new term in charge.

What King has been doing of late is what any sensible but heavily indebted bloke would try for in the likelihood of more pressing debts at higher rates of interest - reducing that debt as quickly as possible. Between February and last week, the Bank of England reduced its currency liabilities from £27 billion to £15 billion. It continues to do so - and equally, is using the same technique throughout for paying off debt - the further reduction of asset reserves.

He's right to be doing it....but there is no escaping the fact that Britain is moving rapidly from balance-sheet insolvency (virtually universal in the developed world) to trading insolvency.

The Devil and the Deep Red Debt

Insolvency: In*sol"ven*cy The state or condition of a person who is insolvent; the condition of one who is unable to pay his debts as they fall due, or in the usual course of trade and business.

(Merriam Webster Dictionary)

Ask nine out of ten economists if it is technically possibly for a country to go bankrupt, and they will laugh. But the real answer is, 'nobody knows because it's never been pressed by the creditors'.

The general (normally rational) view is that no country would ever bankrupt another - especially not an economic heavy-hitter - because the loss of market would cut the nose from the hard face. Also, like an atomic chain reaction, such things can rapidly and unpredictably get out of control.

However, financial, economic, domestic political and geo-political factors have come together in 2008 to suggest that the unthinkable could indeed happen - or rather, we would have to pay a horrendous price in order to avoid it.

Unlike national bankruptcy, the 'horrendous price' scenario has happened to many nations on many occasions - including Britain. Although FDR's lend-lease policy in 1940 (and a great many American lives thereafter) saved our bacon in the Second World War, the scale of the price exacted by the USA can be judged by realising that only three years ago - half a century after the war ended - did we pay back the enormous (and userous) debt incurred.

President Eisenhower shamelessly used the outstanding debt in 1956 to bully Eden into withdrawing from his Anglo-French Suez escapade against Nasser. And at a number of junctures during the 1970s, the IMF overturned the Labour Government's Left-led deficit financing madness by, effectively, threatening to bankrupt us. During the 1980s, countries like Mexico and Brazil could barely break wind financially without legions of bankers descending upon their governments.

Dismissing the idea of political 'pressure' being applied to an indebted country by a creditor is therefore smug to the point of dereliction. (The point applies as much if not more to the USA, and the amount of its foreign debt owed to China; and a united Germany in relation to its trade level with the emergent Putinist Russia. The issue there is currently energy: in the future it will be water.)

Factors that could make a creditor 'go the whole hog' against a technically insolvent UK include:

1. While a big player, we are a smallish import market for all but the minor trading nations. As the world economic crisis deepens, we might however apply import quotas and tariffs which would annoy a powerful trading nation. So in two quite different ways, a creditor might have little to lose from forcing the issue.

2. We are a persistent and voluble opponent of human rights abuses.

3. We have a military and diplomatic influence in some key strategic areas of interest to emergent nations - notably Africa, an insurgency target for the Chinese.

4. A sophisticated and powerful foreign observer would not have much difficulty in foreseeing internal UK chaos which could be to its advantage.

The last point is probably the most important: even without the other three, it presents a potential opportunity to, say, the Chinese and Russian governments - even the EU in the face of our continued truculence - to press a temporary advantage.

Britain at the tipping point: a scenario

How might we arrive at such a crisis? Unfortunately, there is an embarrassment of ways.

Returning briefly to the the Brown & Darling double-act's bizarre assertion of our 'unique flexibility' in facing the coming storm (which of course isn't going to be anything more than a squall anyway) we should not lose sight of the extent to which Mrs Thatcher's nasty medicine left the patient on one leg. Our dependence on banking, insurance and business services is now alarmingly high at 80.4% - precisely the wrong things to be reliant on right now. Just one in five of our income pounds come from industrial output - itself massively hitech biased.

Total debt of the 'nation' UK (ie, all monies, assets etc owed to other countries) is estimated at £1.37 trillion. The trading account would work out roughly to the equivalent of you or I with an ongoing expenditure rate exceeding the salary by 40%, and a short-term overdraft never going below 21% of income.

Our domestic economy is anyway uniquely exposed to personal credit restrictions: no citizens in the developed world owe so much to so many. Personal wealth is equally uniquely dependent on housing, to which over half the adult population is deeply mortgaged. Today we have a triple whammy: credit is tight, rates are rising (regardless of BoE 'guidelines', which barely matter any more) and house prices are collapsing. How any observer (let alone the Chancellor) can envisage 'a slight slowdown' in economic growth given those statistics is mind-boggling.

We have one of the lowest savings rates in the developed world, a population on welfare well above the European average, and unemployment growing alongside inflation.

And we have another five banks at least at risk from the continuing crisis in financial liquidity.

As we have seen far too clearly in the last three months, the Government lacks direction, and is so weak as to have little or no room for wriggling on the tax income issue: backbenchers, hauliers and motorists organisations are up in arms about tax and oil-price rises, while the Unions are becoming increasingly militant in the light of an alarming food inflation-rate.

Given all these factors, the Pound finds itself largely deserted by currency investors: it has lost 18% of its value versus the Euro in just four months. While this theoretically boosts export hopes, at a time when foreign debt is massive, it simply increases the cost of both raising money and maintaining loan repayments.

Rising debt, falling income, rising costs - and potentially infinite insurance liabilities in terms of unemployment benefits, state pensions due to the baby-boomers, potential savers' losses and aged care.

And lest we forget, Free market economics have left one in seven Britons existing at or below the poverty line. The same number again falling into this much-debated pit could alone be ruinous for whichever government is in power.

All this with an instantly acceptable debt-foreclosure reserve of just nine billion pounds. Great Britain in 2008 is a debt-ridden bank operating on a 'run' safety valve of just 0.25% of liabilities: Northern Rock lost the confidence of all its creditors and investors from an infinitely more favourable position. For a pernicious trading nation, forcing us over the cliff would be like kicking at a balsawood door.

Not Born Yesterday

how big an economic crisis can the british government afford?