Economics 101: The Deficit that Neither Tories nor Labour are talking about

We all have a current account and most of us have been in the red at some point. If we can, we pay off our overdraft quickly because bank fees and interest make it expensive. If we don’t pay it off, eventually we go bankrupt.

The UK has an overdraft which is running at almost £98 billion. That’s because there is more money leaving our shores than there is flowing into Britain. Economists refer to this as the current account deficit.

It is important to understand what this beast is and what it isn't. It is less sexy than the budget deficit — which is what the government borrows — and it has barely got a mention in the election campaign. It is arguably as important, if not more than the budget deficit — and it could have a more serious effect on the economy. The last time we got into trouble over the current account it was resolved by Black Wednesday in the early ‘90s.

foreign lenders seem willing to keep the show on the road although it doesn't take much for that to change

The reason we are able to go on spending more than we earn is because foreign lenders — governments and private individuals — lend us the money to do it. They do this because they think we are a safe bet and because they will get their money back, plus a bit of interest.

As long as the music keeps playing, foreign investors will remain confident that they will get theirs back. But they are starting to get tetchy at the £98 billion figure. As J. Paul Getty is reputed to have said: “if you owe the bank $100, that’s your problem but if you owe the bank $100 million, that’s the bank’s problem.”

Measured as a share of our economy, the deficit was 5.5% of gross domestic product last year. In the three months to September, it was 6.1% of GDP — the highest quarterly deficit since modern records began in 1955. That’s the equivalent a £100 overdraft on a monthly take home salary of £1,650.

It doesn't sound desperate, although you might be testing the bank’s patience if you have been saying that you are going to pay it back for the last 17 years — the last time the UK was in the black was in 1998.

Still, foreign lenders seem willing to keep the show on the road, although, as we saw in 2007, it doesn't take much for that to change.

Back then, banks in the US, the UK and Europe had amassed trillions of dollars of complex financial instruments such as sub-prime loans. It took a low-key announcement on 7 August 2007 by the French bank BNP Paribas saying that it would stop investors from withdrawing money from three of its funds, to trigger a domino effect that resulted in the biggest financial crisis since the Great Depression.

It’s Like trying to raid your pension pot to pay Wonga 

Some well-informed people are starting to get nervous about the UK. In classic understated language, the Bank of England has described the current account deficit as an “external vulnerability.”

What worried the bank was not the government borrowing that Ed Balls and George Osborne are fighting about — which has come down — but the private borrowing that is financing the nation’s overindulgence. Particularly, it is alarmed at how banks tend to borrow this money on a short term basis — that’s money that can be called in quickly.

The position of the financial sector would be stronger were it not for the fact that where we are in the black — for instance with our insurance or pension companies — the money is tied up in long-term investments and not readily available to help out the banks.

It’s a situation that isn’t a million miles away from trying to raid your pension pot to pay Wonga at the end of the month.

As the Bank of England points out, UK banks have built up a “substantial dependence” on foreign borrowing. So if foreign financing were no longer available, the UK as a country would be forced to run a large surplus in order to repay in short order what it has borrowed.

No one knows what might spook those who have lent us the money. One source of uncertainty is the General Election and the days or weeks of negotiations between all of the seven major parties that could follow, if as polls suggest, there is no clear winner on May 7.

Whether it’s a tie up between the Labour Party, the Scottish National Party, the Green Party and the Welsh nationalists on the one hand or the Conservative Party, UKIP and Liberal Democrats on the other, neither conveys certainty about the future.

These are the two elements that make things difficult for the UK and for those who have lent the money. First, it’s a huge amount of money and second, there’s uncertainty about the future. It just takes a bit of uncertainty to trigger a bit more and, before you know it, everyone wants out. That’s how debt crises tend to unfold.

Already this earlier this month, the cost of insuring against volatile movements in the pound just after the election increased to its highest since 2010.

It’s not hard to sketch out a situation in which investors become nervous about the political direction of the country and — just to be safe — start taking their money out of the UK.

That overdraft that we got used to over the last 17 years would disappear and we’d be forced to spend less than we earn in order to repay debts. That hurts even in the best of times but, given that we are only just emerging from the last crisis, the effect could be very unpleasant.

Phil Thornton is an economics journalist and author of Brilliant Economics and Great Economists

More about the author

About the author

Phil has run Clarity Economics, a London-based consultancy, since 2007 and, before that, was Economics Correspondent at The Independent.

Phil won feature writer of the year Work Foundation Work World media awards in 2009, and was commended by the Royal Statistical Society in 2007.

He is the author of Brilliant Economics and The Great Economists.

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