It’s a little weird. Central London is booming. Fancy restaurants are packed on Tuesday night. Puny Chelsea townhouses sell for $8 million. Tourists throng Picadilly and Regent Streets. Chippendale mahogany and Tudor oak sell briskly at the BADA antiques fair. You’ll find more Italian shops in the Knightsbridge fashion district than the Piazza della Republica. Chic Sloane Rangers and their immaculately clad kids, walking to school past ornate Victorian mansions, look like they stepped out of a Ralph Lauren ad – all they need is polo mallets and an Irish setter.
But, back in the hotel, the telly tells a different story. On BBC and CNN it’s all gloom and doom—talk of a triple dip UK recession, intractable budget deficits, a bond rating downgrade by Moody’s, the Tories “staying the course” with politically suicidal fiscal austerity.
Why the Disconnect?
To some considerable extent London is more tied to the global than domestic economy. It attracts tourists from around the world. Capital flight from France, Russia and the Middle East supports real estate values and high-end consumption. Many multinational companies select London for their EMEA (Europe, Middle East and Africa) headquarters because of its convenient time zone, propinquity to Africa and the Middle East, historical ties to emerging markets (imperialism’s afterglow), sophisticated financial system, and appealing lifestyle (weather notwithstanding). As an extra double bonus, the lingua franca of global business is English, and Britain doesn’t use the Euro.
But if London, which constitutes a big slice of the UK economy, is booming, then why isn’t the overall economy doing well? To read the Financial Times and New York Times, it’s all about misguided fiscal austerity. Rather than revisit that tired topic, consider some other factors weighing on growth.
- If you scrutinize the specific components of GDP, the weakest is not government spending but exports; a depressed Europe is not buying as much stuff from Britain.
- Two long-time growth drivers are fading: North Sea oil (reserves are running down) and financial services (10% of UK GDP).
- The financial sector’s problems are exacerbated by ruinous regulations coming from the European Union, including a cap on bonuses at 100% of salary (200% with the okay of shareholders) and a transaction tax. Singapore and Hong Kong, here we come!
- Lending to small business is weak because the UK is dominated by a few giant banks, two of them partially owned by the government, that are under regulatory pressure to delever.
- Consumers are overburdened with debt after 25 years of borrowing to buy costly real estate in a crowded country.
- Over-regulation. If you listen to Parliamentary debates, there seems to be a government “scheme” for everything – a “funding for lending scheme,” a “back to work scheme,” a “solar scheme,” plus schemes to reduce drinking, police the media and create apprenticeships. One failed scheme is an energy policy emphasizing costly and erratic wind and solar at the expense of coal, which is hurting real growth and depressing living standards by raising inflation.
Why Should We Care? It’s Not All About the Euro
For investors a basic question is: How much of Europe’s economic malaise can be attributed to a dysfunctional currency, and how much to structural problems such as adverse demographics, excessive government spending and regulation, and a misguided energy policy? The case of Britain suggests that structural problems are critically important. After all, Britain does not have the Euro and benefits from London’s prosperity, and yet the economy languishes. Some of the weakness can be attributed to cyclical problems (such as consumer debt) that should correct over time, but the structural problems are deep-seated and impossible to solve without a lurch toward economic freedom that seems unlikely.
Which makes it hard to be bullish about a European economic revival—particularly because debt phobia prevents Germany from doing its part. While the Eurozone desperately needs a step-up in demand from its solvent “locomotive,” Germany is rushing to balance its budget ahead of schedule even though it is under-investing in infrastructure to the point that the Kiel Canal (which links the Baltic and North Seas and is said to be one of the most heavily trafficked canals in the world) was shut down recently because two locks broke due to inadequate maintenance. The truth is that you can’t have currency integration without financial, fiscal, political and social integration, and Europe is not there yet—not even close.
Copyright 2013 Thomas Doerflinger. All Rights Reserved.
