Are we really so wise to rely upon foreign investors to sustain our deficit?
November 22, 2015
October’s state visit by Chinese President Xi was, according to taste, either a triumph of traditional British mercantilism or a humiliating kow-towing to a ruthless emerging superpower. Ties of Empire and Commonwealth ensured that the trip hot on its heels by Indian Prime Minister Modi attracted less controversy, but both were surrounded by the fanfare of multi-billion pound trade contracts.
Enticing foreign money to these shores is scarcely novel. However, the attraction of government bonds – whether denominated by the UK or countless other ‘First World’ nations, is not what it was.
Perhaps it would be wiser to examine more closely the implications of allowing free movement of capital, whether from Middle Eastern or Chinese sovereign wealth funds or the global oligarchical superrich of the former Soviet Union and beyond.
We welcome open investment in cosmopolitan residential and commercial property; in corporations, especially those rich in intellectual property; in an array of commodities not least as a hedge against Western currencies whose underlying value cannot forever be immune to the effects of colossal Central Bank money printing.
The impact upon the London and Home Counties property markets of international inflows has persuaded many even from the free market centre-right of the political spectrum to contemplate more stringent taxation arrangements for overseas investors, especially those neither domiciled nor resident in the UK. The Swiss or Singaporean models bear some scrutiny, not least as their implementation has not noticeably diminished the appeal as global financial centres of either jurisdiction [click here to read a piece I have written on this subject].
More generally as we continue to spend beyond our means the UK political class needs to grasp that much of our structural and current account deficit is funded by foreign direct investment. Free movement of capital has enjoyed widespread support in recent decades, but it is timely to recall that the income derived in dividends, rents and capital gains from assets owned by overseas corporates and individuals – such as smart new office blocks and substantial shareholdings in public companies – is liable to be exported from these shores in the decades ahead. How will future generations of UK pensioners be able adequately to fund their retirement if the underlying asset base of domestic pension funds continues to be systematically depleted in this way?
Meanwhile the Bank of England continues to issue bonds on a scale unprecedented outside wartime simply to plug the gap between government spending and income. Lest we forget seven years – a full biblical economic cycle – have now passed since the financial crash, yet the public finances (here and in much of the West) remain so precariously (un)balanced.
Much is made of the fact that our central bank has mopped up about a third of the bonds issued during this period, thereby helping enable the emergency interest rate of 0.5% to sustain as it has since March 2009. Potentially, however, the greater distortion is that over 40% of our gilts are held by foreigners. In this uncertain economic environment, where the UK’s performance clearly outshines many of our G7, yet along G20, counterparts, overseas creditors clearly see the UK as a relatively safe haven. However, whilst accepting artificially low returns on their bonds (granted better ‘value’ is not easily obtainable elsewhere) the impact of currency risk may have more serious implications. To date, despite a succession of record high current account deficits, market sentiment towards sterling remains strong. As we know well, confidence is a fragile commodity and if there were to be even a short-term run on the pound, those sterling-denominated gilts in the hands of foreign investors and sovereign wealth funds would rapidly lose their value.
All of which is a timely reminder that the UK’s vastly expanded debt pile over the past decade needs the urgent, drastic, determined action that the new Conservative administration has promised. The period in which markets regard debt benignly may well be running out – the government must be supported in all its plans for rapid deficit reduction.
Even the UK economy’s welcome return to growth since 2012 has been largely funded from borrowing – all that has shifted has been that the typical borrower has been the state, rather than the individual, with a huge programme of asset sales at its centrepiece. As was widely documented during the Chinese state visit even before the most recent multi-billion investment in the UK nuclear industry, Chinese sovereign wealth had been on a spending spree on these shores. The China Investment Corporation (CIC) owns 9% of Thames Water, 10% of Heathrow Airport and continues to make less high profile investments in the oil and gas exploration and property sectors. The Chinese state-owned food manufacturer bought a 60% stake in Weetabix in 2012; China’s second largest insurance group now owns the iconic Lloyd’s of London building whilst last year House of Fraser and Pizza Express were snapped up by Chinese private equity players.
The returns on these UK-based assets and the now Qatari and UAE-owned equivalents will no longer find their way back, via domestic pension funds, into the retirement income of Britons in the decades ahead.
Thirty years ago this month, in November 1985, Harold Macmillan famously spoke of Mrs Thatcher’s privatisation programme as ‘selling the family silver’. Yet virtually all of the shares sold off then found their way into the hands of individual investors or, in time, pension funds and the assets continued to be sweated for domestic gain. Potentially today’s ongoing disposal of public and private assets to overseas buyers has far more serious implications.