Is Britain Overheating?

The 'narrative' of public discourse in Britain is so utterly unmoored in checkable economic data as to be positively delusional. For example, it is astonishing that today's news that Britain had a deficit of £20.8bn in 2Q – that's largest deficit Britain has ever had – barely generates a headline, let alone the alarm it should do. It is missing from Bloomberg's TOP UK, it is missing from Reuters UK headlines, and Google records the only online newspaper which seems to have noticed it is - god help us – the Guardian.

So it's possible you haven't seen that Britain's 2Q deficit in traded goods hit a new record of £28.1bn, and its deficit on international income expanded to £5.2bn – also a record. And you'll almost certainly not be reading that the estimate of the 1Q deficit is revised up to £15.4bn from the previous £11.2bn estimate.

However, this current account deterioration matters a lot, for two reasons:

It suggests that, for whatever reason, Britain's economy is consuming and investing more than it is earning, and at near cyclical extremes. As the chart below shows, Britain had a current account deficit of 3.1% of GDP in 2Q, and 3% of GDP in the 12m to June. The chart also shows that these are historically peak levels: it's where Britain was trading just before the near-recession of 2001, and it's where Britain was trading at the peak of the cycle in 2007.

Secondly, it tells us that Britain's private sector is no longer producing a savings surplus. In fact, during 1H2012 the private sector had savings deficit of £1.2bn, compared to a surplus of £32.65bn during the same period last year. This is an absolutely crucial development, since it means Britain's private sector no longer has a positive cashflow with the banking sector, and that recent levels of domestic demand (consumption, investment) have been running in excess of income (wages, profits). Unless the private sector can now sustain a savings deficit, we should expect British domestic demand to slow from here. What will it take for the private sector to sustain a savings deficit? Simple: a positive flow of cash from banks to the private sector – new lending in excess of new deposits being taken. How likely does that sound?

Of course, all this drives a coach and horses through most of the public 'narrative' about Britain's economy – of how the economy is dying for lack of demand, how more fiscal 'stimulus' is desperately needed, and how only more 'quantitative easing' can save the economy. In fact, it suggests an alternative narrative: that for want of productive capacity, Britain's economy is starting to overheat.

Delusional? Surely no more so than the other narratives we are invited to entertain.