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Bust Britain?

  • Stephanie Flanders
  • 26 Jan 09, 04:29 PM GMT

Is Britain in danger of going bust? It's the question a lot of people have been asking as the pound lurches to new lows.

It makes for a lot of breathless comment. The leader of the opposition even raised the spectre of . But there's a distinct lack of clarity on what it means and how, exactly, it might come about.

There seem to be two big concerns. One relates to the debts of the banking system; the other to the debts of the government.

A person holds an umbrella over the Bank of England in London. Tim Ireland/PA WireThe first worry is that the British banking system has a ton of foreign debts that it would find difficult to repay if sterling spiralled out of control. It's certainly true that the British banking system has a lot of foreign currency debt - the total foreign currency liabilities of UK-based banks were about 拢4.6 trillion in November of 2008 according to the latest Bank of England statistics, of which 拢3.3 trillion was owed to non-residents.

That's the figure that could rocket in value if sterling fell sharply. But a lot of that debt is owed by UK branches of foreign banks. Roughly 拢1.5 trillion of those liabilities are held by UK banks - 拢840bn of it owed to non-residents.

Most important, the banking system has plenty of foreign currency assets to counterbalance that mountain of debt - about 拢4.7 trillion-worth, on the last count, of which more than 拢1.5 trillion is held by UK banks.

When it comes to the debt owed to non-residents, UK banks actually have quite a significant safety margin: foreign currency assets of 拢1.1 trillion to put against liabilities of 拢840bn.

You may not think that the nationality of a bank matters very much any more. (Though it does matter to the authorities, and to the banks themselves. As the , lenders from outside the UK have been responsible for much of the decline in lending to UK companies and households since the autumn. That's because they've been under pressure from their national authorities to keep up lending rates in their home markets.)

Either way, it's clear that UK banks - and the system as a whole - have foreign currency assets which match or exceed their liabilities.

Worriers point out that we don't know what those foreign assets are, or what they're worth in a shrinking global economy. They tend to be riskier than the borrowing on the liability side, and harder to sell in a hurry.

That is all true. But whatever the assets may now be worth, we can be fairly sure that their sterling value would go up in the event of a run on the pound.

The surprising bottom line is that British-owned banks should stand to gain from a lower pound, at least in simple balance sheet terms. Their net foreign currency liabilities would go down. Indeed, Ben Broadbent, an economist at Goldman Sachs, has put this forward as one justification for a "corrective" fall in the pound.

Of course, part of the reason for the markets' concern is that a lot of British banks' debts are effectively being taken over by the government. With all this new debt sloshing around, there is an easier way that Britain could get into trouble: the government could simply run out of buyers for its debt.

With borrowing on the scale the government now contemplates, nothing is impossible. But there's no sign of any buyers' strike happening yet - in fact, the government is still borrowing at historically low rates.

If demand for British debt did start to dry up, the interest rate the government had to pay could start to rise, and that would undermine the Bank of England's efforts to keep lending rates down. That, in turn, could trigger a further flight from the pound.

Any effort to defend the currency with higher interest rates could trigger another set of fears about the shape of the economy. You don't want to go very far along that road with the economy as weak as it is today.

But as I said, the government doesn't seem to be anywhere near that today. And the Bank of England is not about to start reversing its interest rate cuts to defend the pound.

Indeed, you can take some heart from the fact that senior French officials have been publicly fuming about the fall in sterling. They're not worried about Britain going bust. They're worried about British exporters doing rather too well out of a weak currency.

So, we won't be calling the IMF any time soon. And good thing too, because I suspect we'd be put on hold. These days the IMF doesn't have nearly enough money to help us out. It's also being run by a Frenchman.

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