ft

The UK trade deficit widened to its highest level in eight years in 2018 as the services sector weakened, increasing the country’s vulnerability to sudden economic shocks.  The trade deficit hit £37.7bn in 2018 — 1.8 per cent of GDP — from £25bn, or 1.2 per cent, the previous year, according to figures published on Thursday. This drove an increase in the current account deficit — which includes investment and foreign aid as well as trade — to 4.3 per cent of GDP, up 0.8 percentage points year on year. Suren Thiru, head of economics at British Chambers of Commerce, said the widening current account deficit “leaves the UK more exposed to sudden shifts in the economic conditions, including a disorderly departure from the EU”. The UK’s large current account deficit has been financed by substantial foreign capital inflows over recent years which “makes the UK vulnerable to a reduction in foreign investor appetite for UK assets”, the Bank of England warned in the summer. Such a drop-off in investor appetite could be triggered by perceptions of weaker or more uncertain long-term UK growth prospects, which could drive up yields on assets in order to maintain foreign investors’ demand. This “could lead to a tightening in credit conditions for UK households and businesses,” the BoE said at the time. The UK has consistently reported a current account deficit since 1984 because of a shortfall in its goods trade, and it hit a record high in 2016. The UK trade deficit in goods marginally worsened to 6.7 per cent of GDP in 2018, up from 6.6 per cent in 2017. The goods balance is 0.6 percentage points larger than it was in 2015, dashing hopes that weaker sterling would boost British producers’ competitiveness and reduce its trade deficit.  By contrast, the UK generates a trade surplus in services, but it shrank as a share of GDP to 4.9 per cent in 2018, from 5.3 per cent in 2017. The narrowing came mainly from intellectual property and transport services. Last year, the UK exported £104.7bn more services than it imported, according to data from the Office for National Statistics released on Thursday, a nearly 6 per cent fall from a year earlier. Services account for about 80 per cent of the economy and the UK has the second-largest services trade surplus in the world after the US.  Exports of services — which include financial and insurance services, business services, intellectual property, travel and transportation — account for 46 per cent of the UK’s total exports, according to the data released on Thursday, up from 32 per cent in 2000.

Every era of tech has its defining IPOs. From the dawn of the PC (Microsoft, 1986) and the Web revolution (Netscape, 1995*) to the rise of the Faangs (Google, 2004) and China’s new tech champions (Alibaba, 2014), these stock market debuts have been emblematic of their times. Tech’s unicorn era is finally having its Wall Street moment — and it is not pretty. WeWork’s biggest backer, SoftBank, wants to call a halt to a planned listing, while Uber’s shares stumbled to a new low last week, about a third below their IPO price. These have been the two biggest candidates for a stock market listing in 2019, for what was meant to be tech’s Year of the IPO. It comes after a long drought during which the most promising tech start-ups chose to stay private, enjoying a valuation premium in the private markets. But it turns out that the easy cash has bred bad habits. If Uber and WeWork come to be seen as the emblematic deals of a period of excess capital, the investors who have pumped them up will have only themselves to blame. Not that all the new companies Silicon Valley has been trying to foist on Wall Street are as overvalued or as steeped in governance and ethical controversy. On Wednesday, in fact, the market for tech IPOs appeared to be functioning pretty much as intended. Internet services company Cloudflare boosted the price range for its initial public offering in the face of strong demand, while online orthodontics supplier SmileDirectClub raised the price of its shares ahead of the first day of trading, valuing it at nearly $9bn. With gross profit margins of nearly 80 per cent, both companies are founded on solid economics — even if the costs of growth mean each is still spilling red ink. Still, the heightened flow of stock market listings like these during 2019 pales in comparison to WeWork and Uber. The car-booking company was once eyeing a valuation of $100bn or more. Last week it touched $52bn, as California moved ahead with a law that could force it to treat drivers as employees. That would put further stress on a business model that critics claim has been little more than an arbitrage all along, taking advantage of a pool of low-cost contract labour to undercut established services. WeWork, meanwhile, was hoping for an IPO that would bring a premium on top of the $47bn it was last valued at in the private market. Then reality set in. WeWork’s business is also based on an arbitrage, signing long-term leases on office buildings and bringing in tenants on commitments that average 15 months. Wall Street is apparently unwilling to consider a share sale valued at even $20bn. Big valuations swings around a listing are not unheard of. Facebook’s stock fell by 50 per cent soon after its listing on worries that it had missed the shift to mobile, before surging ten-fold in the next six years. But as the products of a period of ready capital, Uber and WeWork have remedial work to do to prove their businesses will be sustainable if the cash tap is turned off. It is not just that the ready supply of cash may have led both companies to overspend (though that could also be a problem — Uber laid off more than 400 workers this week, its second round of job cuts in less than half a year as a public company). Rather, their very businesses were founded on the premise that cheap capital would always be available, and in large amounts. This became a competitive weapon, with uneconomic pricing used to pump up demand for a new service and keep competitors at bay. The aim was to establish an impregnable scale and brand, along with whatever network effects they could muster to dig moats around a new market. During this unprofitable dash for growth, investors were urged to keep their eyes on the pot of gold at the end of the rainbow: a potential market that WeWork put at $1.6tn, while Uber conjured up a total addressable market of more than $12tn. It turns out Wall Street is not so willing to go along with such airy promises. That leaves both companies facing a similar, unappealing set of questions. If they pull back from unprofitable growth and try to pivot to financial sustainability, what will it do their growth rates? And can they make a decent margin from the new territory they have already carved out? A public market corrective was overdue. With remedial work, both could emerge as sound businesses — even if that means some tough decisions ahead. But for tech’s IPO Class of 2019, the damning verdict is already in.

I keep raising the alarm about our current account deficit in FT comments, but no-one seems to be alarmed!  And the article does not even highlight what I consider a key worrying point.  That is that the trade deficit is no longer the largest part of the current account deficit - ie last year's trade deficit was 1.8% of GDP, while the current account deficit was 4.3% of GDP.

What this means is that practically the largest part of the current account deficit (there are some other smaller components, such as remittances) is now investment income payments - interest, profits and dividends, paid to foreign owners of the UK assets that we have sold to fund our chronic and large current account deficits over the years.  While many of these payments are not contractually fixed like debt service payments, the situation is akin to a debt trap - the UK is in danger of falling into a liability trap.

Given that investment in the UK is not historically high - if anything investment is actually historically low - the implication is that the UK is sustaining its consumption by 4.3% of GDP (although we really ought to start using GNI for such analysis) by selling assets to foreigners.  Obviously, this is practically unsustainable, and we might be prudent to cut back, but eliminating the current account deficit implies that, on average over the roughly 28mn households in the UK, each household would need to cut its consumption spending by about £3000 per year, which would come as an unpleasant shock.

I suspect that the Tories have been content with, if not actively engineering, this current account deficit through measures that encourage households to sell assets, including debt assets - ie mortgage borrowing for house purchase - and asset sales under "pension freedom" etc, while encouraging inward FDI.  When what is going on is not widely appreciated, this gives an illusion of prosperity, including by flattering domestic economic activity - eg car dealers selling imported cars with PCPs.  Worse, as the article makes clear, what has been mitigating the situation has been the UK's strong performance in services, but Brexit, and especially leaving the Single Market, with little attention to services - eg even if the UK financial services industry is able to continue some trading with the EU27 via regulatory equivalence arrangements, this is nowhere near as good as the Single Market passport - is likely to clobber services, especially as trade deals tend to concentrate on goods trade more than services.

I fear that the UK is sleepwalking into an economic crisis.