Globalist Analysis

The Coming British Collapse

As Britons prepare to head to the polls, how could a hung parliament provoke an instant financial crisis?

Takeaways


  • While British politics may unfold in a stately, ponderous way, the financial markets operate by a more urgent clock.
  • As the results of the elections become clear on Friday, May 7, the pound is likely to come under pressure.
  • If there is no deal by Monday, May 10, ratings agencies may cut Britain's credit status below AAA.
  • The necessarily deep and savage public spending cuts could keep a party out of power "for a generation."

There has been an ugly symmetry in the way that Britain's general election unfolded alongside the Greek fiscal tragedy and the crisis of the euro.

On the one hand, it has vindicated much of the criticism that Anglo-Saxon economists have made against the euro since its inception. On the other, it could plunge the British and wider European economies back into an even deeper and more painful recession.

Ironically, it was the success in the last televised debate of the most likely next British Prime Minister, Conservative David Cameron, that could condemn him to drink deep of the poisoned chalice that lies in store for the next British leader.

The Chicago-based economist David Hale has cast something of a pall over the British scene by indiscreetly recounting a recent conversation he had with Mervyn King, Governor of the Bank of England.

According to Hale, King said that so deep and savage were the public spending cuts that any incoming British government would have to impose that it would keep his party out of power "for a generation."

It may be worse than that, because of Cameron's success in the final debate. He stopped in its tracks the hitherto extraordinary rise of the appealing young Liberal Democrat Nick Clegg with two well-aimed blows.

With the first, he denounced Clegg's proposal for amnesty for the uncounted number of illegal immigrants in Britain.

With the second, he reminded the most Euroskeptical voters in the European Union that Clegg was the EU's most passionate fan in British politics, and that he favored dropping the British pound and joining the euro.

With Greece on the verge of a default on its debt, the Germans stubbornly resisting any realistic rescue and Portugal and Spain starting their own slides into similar disaster, this was not a week for a British politician to advocate joining the euro.

And much as Clegg protested that he would only do so "when economic conditions were right," the damage was done. For all his fresh appeal in the face of the two unpopular old parties, Clegg's association with the euro and amnesty have hurt him.

But the harsh mathematical realities of the British election system now dominate the future. The latest opinion polls suggest Cameron has 33% of the vote, with Labour and Lib Dems at 28% each. That would not be enough to give Cameron a working majority in parliament.

Indeed, such an outcome would produce the monstrously unfair result of making Labour the largest party (because its votes are spread in such a way that gives them so many seats), and reducing the Lib Dems to a rump.

The BBC projects that such an outcome in votes would result in a parliament of 270 Labour MPs (members of parliament), 267 Conservatives and a mere 84 Lib Dems.

This is where the nightmare begins, since 326 seats are required for a majority. As incumbent prime minister with the largest number of seats, Gordon Brown would remain in Downing Street and seek to negotiate a deal with Clegg for Lib Dem support. At the same time, David Cameron would also be negotiating with Clegg on the terms for Liberal support.

There is a deadline: May 25, the date of the Queen's Speech, when the government in power has to outline its political agenda for the coming year and subject itself to a vote.

If Cameron reaches a deal with the Lib Dems, Brown could be thrown out by losing an early vote of confidence before May 25.

If Brown (or another Labour leader) reaches a deal with Clegg, Labour would remain in office and then have Lib Dem support to win the vote on the Queen's speech.

Either way, precious time will be consumed. And while British politics may unfold in a stately, ponderous way, the financial markets operate by a more urgent clock. As the results become clear on Friday, May 7, the pound is likely to come under pressure. If there is no deal by Monday, May 10, that pressure will intensify, and the ratings agencies may carry out their threat to cut Britain's credit status below AAA.

At that point, the markets will note that Britain has a budget deficit that rivals that of Greece, and that its national debt is soaring unsustainably. Britain must raise close to $100 billion in the world's bond markets this year, and the risk is that investors will go on strike, as they did when Italy tried to sell a bond last week.

Even if the Lib Dems reach a speedy deal (unlikely), a hung parliament would lead to a kind of coalition government, with no clear dominant party and a prime minister constantly having to satisfy two different party blocks.

Given the perilous state of the British economy, that could provoke a very swift and deep fall of the pound, forcing higher interest rates (if the markets would lend Britain money at all) and an instant financial crisis.

Interest rates would have to rise — not to the dizzy heights of over 25% that Greek two-year bonds reached in late April 2010, but to somewhere above 5%.

That would produced an instant jump in mortgage rates and a housing crisis, provoke a wave of bankruptcies of companies that are now clinging on to life, and require the intervention of the International Monetary Fund, on whose client list the UK found itself last in 1976.

And meanwhile, the Greek crisis continues — and interest rates in Portugal and Spain are rising ominously.

Remember that the Great Depression of the 1930s had two triggers. There was the stock market crash of October 1929, followed by what seemed to be a modest recovery. And then in 1931, the government debt crisis hit, and the Great Depression was under way.

That is the worst-case scenario. But there are few rosy ones that could result from the very great likelihood of a hung parliament in Britain this week.

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