We are buying more than we are selling. Last year the UK bought Â£65.6bn more goods than it sold, and the overall balance of payments deficit on current account was Â£31.9bn, or 2 1/2% of GDP. That means a crisis is heading our way, right? According to the Bank of England’s MPC member, Stephen Nickell, the answer’s no, and unless there is a drastic change, there is no crisis looming.
The explanation for this no crisis scenario lies in an apparent contradiction.
Since the mid ’80s, the UK has been consistently running a deficit on its current account. Year in year out, we have been buying more than we have been selling and that means money must have been flowing into the UK, either in the form of debt or investment, to finance this yearly shortfall.
And if money is coming in, assets must be going out. We must have been selling the UK’s family silver to fund this spending.
But here’s the strange quirk of economics. The balance of payments current account is not just trade in goods and services, another important element is net income flow. That’s money received from investments minus money paid out on liabilities. And over the last ten years, a period remember when the total value of our investments should have been shrinking in comparison to the total value of our liabilities, the UK’s net income flow has been soaring.
Over the last ten years there was just one occasion when net income flow was negative, and over each of the last three years it’s been a stunning 2.3% of GDP.
How can our net income from investments be rising, when the net value of investments is falling?
The answer is this: Typically, the money coming in has been in the form of debt. We are borrowing more. But the capital flowing out has been in the form of investment. And that tends to carry much higher long-term return.
Capital investments are measured at book value, not market value, and this is highly significant because the market value tends to be much greater.
The bad news; 2005 saw a net investment flow going in the wrong direction, with the likes of Santander buying Abbey. But overall, the trend has been for investments abroad rising. “Indeed,” says Mr Nickell “the purchase of Mannesmann by Vodaphone and of Atlantic Richfield by BP Amoco in 2000 represented more outward investment by UK companies than the entire total of inward direct investment by foreign companies in the three years 2001-3.”
Mr Nickell said: “Given the speed with which much of the existing positive position developed (ie. over ten years) and given the small reversal of this position in 2005, it is conceivable that this situation could completely reverse. However, the adjusted positive position in direct investment is now of the order of Â£500bn. To turn this into a negative direct investment position of Â£200bn, say, would at current prices, require foreign residents to purchase all the top UK companies in every market sector except Banking, Oil and Mining. This would include BAE, Rolls-Royce, Diageo, BT, Tesco, Unilever, National Grid, Marks and Spencer, Reckitt, BAA, Aviva, B Sky B, Vodafone, Glaxo Smith Kline, Astra Zeneca, BAT, as well as over 35 other major companies. Despite the current attraction of UK companies to foreign residents, the notion that UK residents would cease foreign direct investment while foreign residents bought even a significant proportion of the above-mentioned companies seems somewhat improbable.”
The UK Current Account Deficit and All That Stephen Nickell
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