LONDON — Britain may be emerging from recession, but that is little solace for those who suggest that the economy here might follow in the steps of Japan’s lost decade in the 1990s unless the twin threats of burgeoning national debt and ruined banks are adequately addressed.
The parallels are easy to see: Like Japan, Britain enjoyed a decade of booming growth, fueled by aggressive bank lending and real estate investments. Haunted by the comparison, policy makers have been extra aggressive in using fiscal and monetary levers to prevent the type of sustained period of stagnation and banking stasis that plagued Japan for so long.
Some economic indicators this past week have been positive: an uptick in retail sales, fewer jobs being lost and an export revival. Yet analysts say they may well turn out to be tease, cloaking deeper, more structural flaws in the economy. On top of rising debt, the tax base is collapsing and the crippled banking sector has yet to show it can generate profits by lending to corporations.
“We expect 1 percent growth next year and 0.7 percent in 2011,” said Douglas McWilliams of the Center for Economic and Business Research in London. “Technically it’s a recovery — but it’s a very weak economy indeed.”
Comparisons with Japan have been made in the United States as well, but some believe that the more appropriate analogy is Britain, given the more pronounced contribution that the banking sector has on the economy here.
The prospect of a period of Japan-like outcome in Britain was publicly aired last month by a senior member of the Bank of England’s monetary policy committee, Adam S. Posen, who was just appointed in June.
An American and a senior fellow at the Peterson Institute for International Economics in Washington, Mr. Posen was speaking as an outside expert on Japan’s lost decade. He noted his views were his alone and not those of the bank.
But they also carry the weight of one of the decision makers on the bank’s strategy of buying of government bonds, known as gilts, as a means to inject liquidity into the economy, a policy called quantitative easing.
“The United Kingdom has an uncomfortable parallel with the Japanese financial system when the Japanese economy began to recover in the mid-1990s and was unable to sustain it,” he said in his speech. “The closer one looks, the more worrisome this specific parallel becomes, given the concentration of the UK banking system in few major, mostly still troubled banks, and the relative underdevelopment of alternative non-bank channels for getting capital to non-financial businesses in the U.K.”
While defending the quantitative easing as necessary and non-inflationary, Mr. Posen also pointed out that the Bank of England’s massive purchase of gilts — the bank now owns 30 percent of those outstanding — is in itself a consequence of the British financial system inadequacy in providing credit to businesses through the issuing of corporate bonds.
Like Japan, the capitalization of Britain’s private sector bond market as a proportion of gross domestic product is very low — 0.16 percent, the smallest among G7 economies and significantly behind the U.S. figure of 1.2 percent.
For a financial system heralded to be one of the world’s most sophisticated, this is an eye-opening statistic and it raises the possibility that credit starved corporations, dependent as they are on Britain’s still-wobbly banks, may not get the capital they need, all of which might bring about a double-dip recession or even a Japan-like slump payday loans.
Mr. McWilliams of the Center for Economic and Business Research forecast that bank lending to corporations will decrease over the next two years.
Mr. Posen would argue that the Bank of England’s buying of gilts is unavoidable, especially in light of the fact that sufficient liquidity does not exist in the private bond market.
But a growing number of bearish analysts see the bank’s buying spree as dangerously distortive, in that interest rates have been kept at a low level that does not reflect the dire state of Britain’s public finances.
The severity of the problem was underlined this week, when the government released an £11 billion borrowing figure for the month of October, which brought the half-year tally to £86.9 billion, the highest since public records began in 1946. That makes it almost certain that the government’s forecast of £175 billion of borrowing for next year would be exceeded. And it would produce a budget deficit of about 13 percent of G.D.P., or nearly twice the average in the euro zone.
Simon White, a partner at Variant Perception, a London-based research house that caters to hedge funds and wealthy individuals takes an especially dire view.
There is a caveat: Variant Perception, which is run by former traders, is noted for its contrarian perspectives on certain markets. A few months ago it put out a controversial note on Spain’s real estate troubles titled “The Hole in Europe’s Balance Sheet.”
Still, its negative view on British gilts and sterling is one that is becoming more and more mainstream.
In a note sent out to clients this week, Variant broaches the prospect of a debt and/or currency crisis as Britain’s collapsing tax base — too dependent on real estate, financial firms and the already highly taxed rich — results in declining revenues.
Taken together with the already high levels of spending, the result is a deficit that grows even beyond 13 percent of GDP, further harming the country’s fragile creditworthiness. (Both Fitch and Standard & Poor’s view Britain’s economy as the most vulnerable to a downgrade of the 20 or so countries that carry a AAA rating.)
Once the Bank of England, which has already spent about £200 billion buying British bonds (or about 14 percent of annual G.D.P.) stops, rates are expected to immediately push up. That could prompt already skittish foreign investors, who hold more than 30 percent of government paper, to become sellers.
To be sure, such a scenario presumes that British politicians will be like their counterparts in Japan in the 1990s and not have the political will to tackle these economic problems — a bold assumption given that the Conservative Party, which is far ahead in polling for a spring election, has staked its legitimacy on bringing down the country’s debt.
Still, until more such conviction is shown, worries about a period of stagnation, or a more devastating shock, are expected to continue.
“The likelihood of a debt and sterling crisis is just not factored in,” Mr. White said, noting that, on average, these types of crises have occurred every 15 years since 1947, with the last occurring in 1992. “If this gets out of control it will flip very quickly.”
Fears of ‘Lost Decade’ Grow for British Economy