John Redwood, Evercore Pan-Asset

A tale of two countries

John Redwood, chairman of Evercore Pan-Asset’s Investment Committee on efforts by the UK and Spanish governments to rebalance their respective economies…

This week saw the Spanish authorities seek to cut a further EUR10 billion from their public sector budgets, in an attempt to stave off further rises in their 10 year and other borrowing rates. The ECB rode to their rescue by saying it would consider buying more Spanish government debt, once the government had pledged more austerity. The problem remains intense in Spain, with 23% unemployment, no ability to devalue its own currency to try to price itself back into markets, and always at the mercy of the bond markets.

The UK is in contrast still enjoying low borrowing rates, thanks to a large quantitative easing and bond buying programme by the Central Bank. It is also seeking a recovery with more exports, following devaluation. It has lower unemployment and a competitive service sector which earns a healthy surplus. The London economy is relatively strong, attracting talent and capital from around the world.
 
The two countries do share some similar problems. Both experienced overextended credit and property bubbles. Both ended up with weak banks as a result of the Credit bubble excesses. Both have large public sector deficits and growing burdens of public debt. Both now have governments seeking to rein in those deficits primarily so far by tax rises, which in turn squeeze the private sector more. The majority of the EUR27 billion of “cuts” in the latest Spanish budget took the form of more tax revenue or higher utility prices resulting in lower state subsidies, putting the squeeze on the private sector.
 
The UK yesterday published some disappointing trade figures. The private sector led recovery envisaged by the government requires a good improvement in overseas trade results. The February figures saw a GBP1 billion increase in the overall trade deficit from January, owing mainly to a fall in the export of goods. It is not wise to read too much into one month’s figures, but the deficits with both China and Germany remained large and the deterioration was worse outside the EU area. Fortunately services held steady with a strong GBP5.4 billion surplus to offset more than 60% of the goods deficit. Goods exporters pushed up prices, cutting some of the advantage of the devaluation, in response to increased energy and raw materials prices.
 
Rebalancing economies with balance of payments deficits, large state sectors, and slow or no growth is not easy. Trying to do so without the capacity to change the currency level or run your own credit and money policy is considerably more testing, as Spain is discovering.

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