The past decade has been a golden one for the British, and Brown repeatedly claimed credit for it. Everything seemed to go their way:
- The global economic environment has been unusually friendly, driven by the industrial revolution in Asia, an astonishing credit-fuelled boom in the US, and a Europe savouring the rewards of the ending of the cold war.
- Thatcherite reforms such as the curbing of labour union power, privatization, and liberalization of the labour, forex and property ownership markets, greatly strengthened the economy. Incoming New Labour, having shifted to the political centre-ground, made no attempt to reverse those reforms. Indeed, in his early years as finance minister, Brown stuck to the tight limits on growth of public spending inherited from the outgoing Conservatives.
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- The growth of global business, an explosion in the scale and complexity of financial products, an unusually-friendly attitude towards foreign investors, relatively light regulation, and its traditional pool of financial skills, brought huge rewards to the City of London and to the wider economy.
- The global low-interest environment, with the lowest rates in 40 years, triggered an unprecedented boom in residential real estate, as it did in the US. The "wealth effect" of rising property values encouraged confidence among consumers, who were willing to go into heavy personal debt. The flood of borrowed cash drove retail demand for goods and services.
- As Brown managed the nation's finances to smooth his accession to the premiership and underpin Labour's grip on power, he started to pour huge amounts of money into the public services, pandering to the party's core supporters and putting up to a million extra workers on the public payroll.
- Even Labour's incompetence and misjudgements produced favourable effects. As a consequence of planning failures, poor border controls and shoddy administration, Britain has been flooded with several million legal and illegal immigrants who have powered economic expansion.
Why Britain now faces hard times
With full employment, moderate inflation, interest rates that are still low, and most of the additional burden of financing public services hidden from view in so-called "stealth taxes," the British public is not yet fully aware of how hard things are going to get.
The world economy is slowing down. Yet inflationary pressures are rising, making it difficult for central banks to cut interest rates.
The housing boom is over. The International Monetary Fund says UK residential properties are up to 40 per cent overvalued. The average home is priced at 7 times average household disposable income the highest ratio ever. A painful correction some fall in prices is inevitable.
The City's glory days are over. No more structuring dodgy credits into packages for sale to nave institutional investors; no more easy launches of hedge funds providing lavish fees for mediocre performance; no more takeover battles financed by dirt-cheap bank credit.
The public services expansion boom is over. Brown has run out of money and the fiscal deficit is forecast to inflate to the equivalent of $100 billion a year in the 2008-09 year (and that's without allowing for the costs of Northern Wreck).
Britain enters a cyclical downturn without the fiscal surplus that would allow government to stimulate the economy by increasing spending or cutting taxes. Indeed, falling profits could mean falling revenues and force Brown to impose tax increases.
The collapse of the three primary drivers of Britain's economic growth in recent years, in an environment of global slowdown, means that tough times are now inevitable.
And unfortunately the economy is not in good shape to cope with such times. The surpluses of the golden years, which should have been invested in infrastructure and reforming management of public services, were largely wasted to promote Labour's political objectives.
The state has accumulated vast debts, mostly off balance sheet and therefore hidden from public view. There is a big foreign trade deficit close to 6 per cent of gross domestic product, or relatively much worse than the US's. Productivity growth has slowed. And Britain's over-regulated, over-taxed entrepreneurs increasingly threaten to take their skills elsewhere.
Lavish spending on centrally-planned education and medical services has produced bloated bureaucracies, but without raising standards of tuition or healthcare. In fact standards, especially in education in leading-edge skills such as maths and sciences, have been declining.
What does all this mean for investors?
It is easy to be too pessimistic.
Although the housing market faces difficult times, a generalized collapse is unlikely. A supply/demand imbalance underpins values. Easy-credit malpractices were never as widespread in the UK as in the US.
The country has a growing population with a younger age profile than other major European nations and with particularly vigorous communities of recent immigrants, mainly from Central/East Europe.
London is where the mega-rich want to be
Britain has a strong competitive position in service industries such as finance, private education, media and entertainment, with an openness to foreigners and a vigorous cultural life that makes London the world's leading truly international city, where the mega-rich want to play, shop and own a holiday home.
Socially and politically, the country is stable and safe. Notwithstanding recent scandals over political funding (for relatively trifling amounts), there is little corruption.
Investment markets are very large, diverse and sophisticated, with high standards of accounting, transparency and regulation.
London remains ahead of New York as the leading centre for international business, its stock exchange increasingly listing companies operating in China, Russia and other emerging economies. More than half the profits of all the companies listed in London are earned outside the UK.
Because of its foreign trade deficit, Britain will need to keep its interest rates relatively high to attract foreign capital and prevent a currency collapse and an explosion of inflation. That suggests sterling will weaken somewhat this year, but isn't likely to collapse. It is not a carry-trade currency, being neither particularly cheap to borrow nor particularly high-yielding to invest in.
Overall, things are going to be tough for the Brits, whose lifestyle quality has already deteriorated for reasons unconnected with the economy bossy but often incompetent bureaucrats, regulatory and red-tape mania, extensive social breakdown in many areas of major cities, poor public services and a bloated welfare system riddled with fraud.
But investors, whether based in the UK or outside it, can evade most of those problems if they are carefully selective. As the world's second largest stock market, London is sufficiently diverse to offer investment opportunities.
By Martin Spring in On Target, a private newsletter on global strategy
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