A globalisation loser

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Financial services contracting…

By James Saft

LONDON (Reuters) – Britain, one of the big winners from the free flow of capital and services globally in the last decade, is rapidly becoming one of globalisation's losers due to its reliance on property and finance.

With financial services contracting and the international flow of capital that funded a debt binge in an almost total freeze, Britain's economy, housing and financial markets are in a headlong race lower that makes problems in the United States seem slow moving in comparison.

Britain's famously open economy has had a stunning run of uninterrupted growth over 15 years, as it successfully transformed itself into a services and consumer society. The City of London financial centre boomed, arguably winning pre-eminence over New York, while international capital from Russia, Asia and the Middle East found a base in London.

At the same time Britain's regions enjoyed smaller-scale but still buoyant growth, much of it connected in one way or another with a near tripling in property prices over a decade.

Now the shutdown of the flow of international capital to its banks and borrowers has brought that to a halt, while a spike in the cost of energy and food hurts consumers.

It is really rather difficult to give a sense for exactly how quickly Britain's economy is coming unglued.

According to the Nationwide building society house prices fell by 2.5 percent in June alone, and some economists are now forecasting multi-year falls of as much as a third. Mortgage lending is down by 64 percent year on year in May, as banks recoil from lending into a falling market and also due to the simple fact that Britons collectively don't deposit enough to cover their borrowing needs.

John Lewis said sales at its department stores dropped 8.3 percent in the week ended June 28, compared with the same week a year earlier, while rival Marks & Spencer (MKS.L: Quote, Profile, Research) also reported disappointing results, driven in its case partly by Britons choosing less expensive food.
The banking sector is racing to recapitalise, not entirely successfully, with mortgage specialist Bradford & Bingley's shares now trading well below the level at which a new offering of stock was underwritten.

Construction activity fell at its fastest pace in at least 11 years in June, while the crucial services sector shrank at its sharpest rate since just after the September 11 attacks on the United States.

Even manufacturing contracted in May, according data released this week, though to be fair it would almost take an industrial revolution for Britain's small sector to make up for shortfalls in property, consumption and finance.

The upshot is that Britain is very likely already in recession, and that its financial markets, though hard hit already, have further to fall.

SECURITISATION AND ITS DISCONTENTS

So how will the UK experience of a property bust stack up against the United States?

Karen Ward, chief UK economist at HSBC in London, estimates that the construction, real estate and related sectors account for 10 percent of employment. The U.S. comparison is not exact, but is something on the order of 7 or 8 percent.

"You only have to walk down any village high street in the UK and it is estate agent after estate agent," Ward said.

But why is this about globalisation, rather than simply being one more story about a property bubble?
Britain in effect concentrated on those things in which it had a comparative advantage, notably finance, and outsourced the rest.

Whereas productive industries are essentially flat in growth since 2003, financial intermediation has grown by 50 percent and real estate activity by 35 percent.

Britain's very openness, and its willingness to adopt innovation, especially financial innovation, allowed it to fund a consumption and property bubble that could persist only so long as money flowed to its consumers from abroad. Its banks, notably Northern Rock, borrowed from abroad, and its house buyers did so too through securitised mortgages. That all ended last summer.

Don't get me wrong: I don't at all blame Britain's problems on perfidious foreigners. It was a free contract that people across the country grasped with both hands.

Now globalization too will limit Britain's ability to respond to the end of cheap money.

Financial markets have the power to punish sterling and government bonds if official borrowing becomes more aggressive. That leaves the government in a poor position to stimulate the economy with additional spending, given that even on its own now optimistic forecasts it will only narrowly avoid breaching its sustainable debt rule.

As for the Bank of England, its ability to soften a downturn with official interest rate cuts is constrained by global food and energy prices that have driven inflation to 3.3 percent, well above its 2.0 percent target.

Its commitment to that target, and all it implies, will be tested as the year unfolds.