As we feared, there is a wobble in the main equity markets. Some traders are taking some profits. Some commentators are noticing that there is a big gap between what share prices are forecasting, and the present economic experience on the ground in the US and UK. It is a good time to look again at the big picture in the UK and remind ourselves why we are still cautious about UK assets.
For the private sector to be too much in debt may be careless. For the public sector to be too much in debt may be inconvenient. For the banking sector to be too much in debt might be worrying. For all three to be too much in debt at the same time is dangerous.
That is the position of the UK today. The boom phase encouraged excess debt in the private sector. Now individuals are busily repaying credit card debts, mortgage advances are well down on peak levels, companies are being forced to repay debt out of cash flow and asset sales or raise more money from shareholders. The private sector has been told in no uncertain terms to spend less and pay back more. The message is reinforced by high interest rates on most private borrowing, by scarce credit, and tough banks.
The government also used the boom to expand its borrowing, particularly off balance sheet. It set up lots of Public Private Finance Initiatives, Public Private Partnerships and other routes to disguise public borrowing. It expanded its workforce and raised public sector salaries substantially, greatly increasing the public sector pensions deficits, and the costs of future unfunded pensions. Since the Credit Crunch it has expanded its conventional borrowing substantially.
The banks, encouraged by their Regulators who allowed bank balance sheets to expand, increased their lending and then multiplied its effects through a large number of new complex financial instruments.
As a result we have a country weighed down by huge debts. The challenge for the next government is to help all sectors chart a course out of excess debt.
The private sector will adjust its own demands. There is already evidence of people doing just that, with credit card and mortgage lending falling. This process will unfortunately be speeded by the increases in unemployment that are happening, and by the interest rate rises to come.
The banking sector can also cut its leverage. The government owner of two major banks should be tougher in demanding cost reductions, asset sales and other mechanisms to get these banks into a stronger shape more quickly without recourse to public subsidy. The UK economy will not work well until the banks work well. RBS and Lloyds have been offered substantial new capital and guarantees, delaying the necessary cost adjustments and business improvements they need to make.
Which leaves the government sector. The three largest political parties all now agree that government needs to cut its spending. All agree that government can be more efficient and should strive to do more for less. Each party has identified a few items which they would like to see cut out of budgets altogether. That is a start.
The problem is the magnitude of the tasks. If markets are to remain optimistic there needs to be a clear course for cutting these excessive borrowings. A strong economic recovery would help curb all three deficits, swelling personal incomes, adding to company profit and cash flow, cutting the numbers of unemployed and helping banks win profitable business. This can only happen if there is general confidence in the economic policies being pursued. The treble deficit strategy is a high risk one. If these three deficits are not visibly coming down soon, it will mean higher interest rates and more difficulty for the UK to borrow money, which will be bad for the recovery as well as for the main borrowers.
It is going to take time to adjust the large imbalances around the world. The high savings successful exporting economies have problems as well, but these problems are not quite the same as having to finance three very large borrowing requirements as the UK has been doing. Something will get squeezed. So far it has been the private sector.