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Who’s the Next Downgrade Domino to Fall?…The UK? 

Contributed by George Dorgan, a macro-based fixed-income and currency overlay portfolio manager based in Switzerland, and the main editor of the blog SNB & CHF.

After Moody’s downgraded France, we are waiting the next major sovereign to suffer the same fate. According to the must-read interactive graph on the BBC, France now has a medium risk of default, but the UK is still in risk status “low”.

UK Risk Status (source BBC)


According to the BBC, each citizen of the United Kingdom has €117580 of foreign debt. 436% (BBC data) of a total of 507% GDP total debt (see below) is in foreign hands.



But the BBC states:

This level of overall external debt is generally not seen as a problem because the UK also holds high-value assets.

Aha ok, I understand, there is no problem with having 436% of GDP in foreign debt, namely because the UK holds high-value assets. Some of these ”high-value assets” are the following:

  • 9 bn € Greek debt (according to BBC high risk)
  • 104 bn € Irish debt (according to BBC high risk)
  • 19 bn € of Portuguese debt (high risk)
  • 55 bn € Italian debt (high risk)
  • 75 bn € Spanish debt (medium risk)
  • 227 bn € French debt (medium risk)

Hence a total of 489 bn €, yes we understand, “high-value assets” using the same BBC interactive graph.

France, however holds:
  • 41 bn € Greek debt
  • 24 bn Irish debt
  • 19 bn Portuguese debt
  • 309 bn Italian debt
  • 112 bn Spanish debt
A total of 505 bn € of assets with medium and high risk.

UK’s negative current account and negative investment position


On the other side we see a weakening of the already negative current account and a weakening negative net international investment position (NIIP).

UK Current Account
UK Net International Investment Position NIIP

Upcoming triple dip recession and lack of competitiveness


Apart from upcoming triple dip recession, we see inflationary pressures in the difference between the producer price indices for input and output. Input price changes have come down to 0, but output prices have risen by 2.6%. This leads to continuing wage inflation, which, as opposed to countries like China, Germany or Switzerland, is not reflected in improving trade balances or current accounts. For us it is a clear sign of lack of competitiveness.

Input and Output Prices UK (source National Statistics)

Partiality of US/UK Rating Agencies


This one thing seems to be clear for us: whoever downgrades France, must do the same to the United Kingdom.

But we know that Moodys have one of their main offices in London, mostly British and American share holders. Apart from Standard and Poors’ highly criticized US downgrade in August 2011, the leading three rating agencies seem to be very myopic with regards to the United Kingdom and the United States. Would they saw through the branch on which they were sitting?

They probably do want to have the same fate like Egan Jones that, after its downgrade of the United States, faced legal action from the SEC for a years’ old action. Cross-posted from SNB & CHF.

Also by Geroge Dorgan: Euro Morons: Hyperinflation Successfully Avoided, Stagflation Successfully Created 

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Reader Comments (3)

This is an interesting snapshot but what would the situation look like if the European banks were re-capitalised as per the UK?

The UK is in trouble no doubt but if and when the euro banks are recapped the situation could look equally dire for euro states.

Using % of GDP as a reference point can also distort the picture as it includes government spending which form a large % of euro GDP.

Anecdotally I recently had a job offer in Brussels. The renumeration at first glance looked excellent but by the time I investigated the tax and administration regime I turned it down flat.
November 26, 2012 | Unregistered Commentermighow
It is worth considering that part of the reason there is so much external debt in the UK is because it is one of the World's largest financial centres. From Wikipedia...

Note that the use of gross liability figures greatly distorts the ratio for countries which contain major money centers, e.g. United Kingdom, because of London's role as a major money centre.

So I wouldn't get too excited about it.
November 27, 2012 | Unregistered Commentermaybe maybenot
London's role as a major financial centre doesn't excuse the debt at all - that's just what The City wants you to believe. In fact it's entirely the oppposite. The huge financial debt is showing the size of the finance sector relative to the rest of the economy and the synthetic debt being generated in London. If you want to know more then google "unlimited re-hypothecation" and "Joe Cassano". The UK is in very very very serious trouble.
November 27, 2012 | Unregistered Commenterfuninabox

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