The collapse of European economies has now begun, starting with the continent’s weakest economic link: Britain.
This country’s collapse was triggered by the release of the new Government’s budget last Friday. The budget was ridiculous – an expansionary package in an economy with high inflation and an enormous trade deficit – and it sparked a sell-off in the gilts market, which soon spread to the market for sterling. Pension funds are now facing huge losses. Next will come more inflation, a recession and higher unemployment.
The media has leapt to blame the Government – as if a single budget announcement could trigger a full-scale economic collapse. “Are you ashamed of what you’ve done?” BBC Radio Kent asked Liz Truss, in a shallow spectacle that has become all too common in contemporary Britain.
The truth, however, is that the budget was just an excuse. The financial markets have been making noise about the economic situation for weeks. At the beginning of September, traders were jokingly referring to the “British peso”; rumours were circulating of British bond trading desks handing off their trades to the emerging markets crisis desk. Anyone with any exposure to the City knew what was going on. That should have included the Bank of England and the Treasury – who appear to have been asleep at the wheel since the war in Ukraine started; nay, since the lockdowns started.
What was the City worried about? High inflation and an out-of-control trade deficit. At the end of August, Goldman Sachs projected inflation in the U.K. would reach 22% next year. A few days later Deutschebank projected a current account deficit of 10%, something unprecedented outside of basket-case emerging markets that experience serious financial bubbles.
What was the cause of these imbalances? The answer is simple: energy costs. Britain imports a lot of energy. When the cost of energy rises, imports balloon and the trade balance collapses. These higher costs are passed on to consumers and henceforth comes inflation. This is a crisis not simply facing Britain but all of Europe; Britain fell first because it was the slowest animal in the pack.
This is because Britain has long relied on the City of London for its prosperity. Britain does not have a serious manufacturing base, so sterling relies on financial inflows to the City. In an economy that relies on manufacturing – like Germany – the current crisis takes longer to manifest. In Germany, energy prices will have to rise a bit further before industry starts to shut down. At this point, exports will collapse, inflation will soar, European bond markets will sell off and the euro will tank.
This is already happening, but gradually.
In Britain, the whole crisis can be priced in immediately because all it takes is for the City of London, and the international banks and money managers with whom it does business, to realise the gravity of the situation, and then press a few buttons. That makes Britain a sort of canary in the coal mine for the whole of Europe – something that European politicians are gradually waking up to.
There are now two possible paths. The first is that the sterling and gilt markets continue to sell off in the coming weeks and sterling follows them down. The second is that they calm down but then, as winter bites, inflation gets worse and the trade balance deteriorates, it starts all over again. At the time of writing, the former seems more likely.
Is there a way out? There was until Monday when someone sabotaged the Nordstream pipelines.
Most people – myself included – thought that after the economic chaos this winter, Europeans would cave on the Russia sanctions and Nordstream would be reopened. That is no longer an option. Energy prices in Europe are now permanently higher – at least until we start building new capacity, but that will take years. There is simply no way out. The collapse of the pipeline on Monday was like that scene in the movie where the cave entrance is covered in rocks and the hero is trapped inside.
All of this was perfectly and tragically obvious. By May, it was undeniable that the Russia sanctions were not working. But we pressed on anyway with the media pumping out idiotic nonsense week after week. When Russia started to cut off the gas, it was equally obvious that the economic consequences would be devastating, especially for Britain. But those of us who said anything were dismissed as Putin apologists – and the media gave a voice to those who made promises about LNG (Liquified Natural Gas) that could never be kept.
Well, here we are. The cheque has bounced, and the economy is in freefall. Nordstream is a smouldering wreck at the bottom of the Baltic Sea. There is no turning back.
Philip Pilkington is a macroeconomist and investment professional. You can follow him on Twitter here and subscribe to his Substack newsletter here.
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