Brexit's Economic Windfall is a Delusion
The post-Brexit economic news has put Brits in a sunnier mood, but the holidays are over and now it's time for a reality check.
The economic adjustment from the referendum result hasn't been averted, it's simply been deferred. The hit to investment has yet to be felt and Britain is ill prepared.
True, U.K. retail sales, home sales and consumer confidence surveys have been fairly upbeat. However, a more impartial expert on national maladies -- the currency markets -- has emphatically concluded that the U.K. has a problem, and that judgment has a genuine economic impact.
Households are financially worse off, even if they might not know it yet. The weaker pound will raise the cost of imports, though that impact will take a while to feed through. Household purchasing power is destined to suffer, since wage gains are unlikely to pick up to a point that can offset the inflationary impact of sterling's slide.
Right now, corporate boards would be reckless to approve new projects in the U.K. given the uncertainties about the country's future trading relationships with the EU, the destination for almost half of its exports. A slump in foreign direct investment seems all but assured.
A weaker currency of course makes all of Britain cheaper, and shortly after the Brexit vote Japan's Softbank announced it would buy U.K. chip designer ARM for more than 24 billion pounds ($31.5 billion). Theresa May's new government celebrated that sale as evidence that the country had lost none of its allure to international investors.
This is a delusion. Britain has been living well beyond its means for years, and has no choice but to borrow or sell off the nation's treasures, including promising tech companies and swathes of prime London commercial and residential property, if it wishes to continue to do so.
The big problem is that its current account deficit -- the difference between money coming into the U.K. and money sent out -- has reached an astonishing 7 percent of GDP. Before the referendum, Bank of England governor Mark Carney warned that the nation's dependency on the "kindness of strangers", in the form of persistent foreign support, created a worrying vulnerability.
Remarkably, the ARM sale alone covers more than two months of the U.K's current account deficit all by itself. 2 Persuading foreign capital to continue investing in more domestically focused assets, or anything reliant on unencumbered trade with the EU, will be far more difficult. Worryingly, an EY study showed more than three-quarters of investors abroad were attracted to Britain because of its link to the single market -- a connection that's now at risk.
To be sure, sterling's decline will ultimately help the U.K current account move closer towards balance by boosting the returns Brits derive from non-sterling denominated assets. Exports might also get a boost -- but that's a big might. Overall, Carney expects the current account deficit to halve over the next three years.
Even so, to avoid sterling falling too far and keep the deficit funded Britain needs foreign money to continue flowing in.
What's to be done? May should start by taking a hard look at the UK's profound bias toward debt-fueled consumption and services. If capital flows serve only to further inflate the real estate sector, Britain won't necessarily be better off.
Reviving Britain's industrial base should be a top priority, but that'll be tough -- many of Britain's trading partners want to do that too.
She also needs to get a grip on the Brexit talks and spell out how the U.K. will remain a haven for foreign capital. Greenlighting Chinese investment in the controversial Hinkley Point nuclear project may be unavoidable.
Strangers have been kind to the U.K. up until now, but their patience is wearing dangerously thin.
Yes, U.K. gilt yields have plunged and the FTSE 100 is nearing a record high in the wake of Brexit. But these say more about the Bank of England's asset purchases and a global hunt for yield than Britain's domestic economic prospects.
Not all of ARM was owned by British investors, but you get the point.
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