It is quite possible that the outcome of next week's UK parliamentary election
could produce a split, non-majority government without parliamentary support
needed to trim its budget deficit. The last time the UK experienced a
non-majority government was 1974. Edward Heath was prime minister and conceded
leadership as lack of a majority to Harold Wilson (a second-timer who fared no
better), the IRA was in full force bombing all over the UK, inflation rampant,
double digit unemployment, trade unions striking at will and slowly turning
England into the "sick man" of Europe. Even socially things were dubious with
Paper Lace's "Billy Don't Be a Hero" and Carl Douglas' "Kung Foo Fighting"
topping the music charts — and this from the land that produced such greats as
the Who, Stones, Beatles as well as countless other greats as part of the
"British Invasion"! Alas, all this set the stage for the Thatcher revolution and
the birth of the Sex Pistols — both in a way radically changing their
worlds.
That said, the UK today has little in common with the conditions
in 1974 outside the strong chance of a no majority government prevailing after
May 6. The lead up to the election has seen the GPB weaken the most against the
JPY after a leading poll showed 32 percent of respondents backed David Cameron
and the Conservative Tory Party (who appeared to have "won" the final debate),
31 percent favored Liberal Democrats, (thanks to the seemingly out-of-nowhere
splash of Mr. Clegg, who can thank that little invention called the television
as Britain had its first live candidate debate on that ubiquitous box) and 28
percent supported PM Gordon Brown's Labour Party. Conventional wisdom concludes
that, should this split hold, it will be negative backdrop for sterling. Indeed,
the GBPUSD, while seeing upside tests of 1.5520, has fallen back to the mid-1.52
area given the uncertainty, though some of this volatility has to do with the
PIIGS issues.
Two legacy problems plaguing all candidates and the
question of how to move forward are embodied in a little statement by Business
Secretary Peter Mandelson. Mr. Mandelson, who sought to reassure investors that
a hung Parliament would not lead to instability after the election, concluded
that the market has discounted this, knowing that "in our political system, you
will get sensible, stable grown-up politics." This is an astonishing statement
given that the current administration found the only way out of its mounting
debt is to simply raise taxes to the moon. Also, let's not forget the many,
many members of Parliament who have faced expulsion or shame on tawdry
expense scandals. Some doozies include: Cabinet Minister Douglas Hogg using the
gentry's money to clean his moat, tuning his piano and repairing horse stable
lights at his country manor; and other members using public funds for things
like swimming pool refurbishment, pewter-finished radiator covers,
illegitimately flipping second homes, misuse of governmental allowances for
rents/mortgage deductions, window replacements, light bulbs, newspaper cutting
services, love seat purchases, electric gates at manors, new lawnmowers, the
purchase of 215 trees and — the real winner — spending 35 pounds on chrome
toilet roll holders. The poster child for it all is Home Secretary Jacqui Smith,
whose husband spent taxpayer money watching pornographic films. So, if the
market is skeptical of Peter Mandelson's claim, it should be
understood.
The fun aside, the UK faces three critical issues that are
not dissimilar from the U.S. in a small way as well as the rest of Europe: very
high budget deficits, a shaky economy and financial infrastructure on unstable
ground. The key problem affecting the GBP now is how to tackle the budget
deficit. It jumped 76 percent in the year through March to its highest levels
since WWII, at GBP 152.8 B or about 11.4 percent of GDP. Greece is at around 12
percent and Portugal at 9.4 percent in Q1-10, while the U.S. is fluctuating at
around 12 percent. So, not the end of the world and given the Greek situation,
gilts have benefited from flight to quality, limiting the risk of treasury
funding. If the elections produce a hung parliament, the question is how the
market will come to any consensus on action.
Let's review each
candidate's prescription for repairing the public finances. The Labour Party's
Gordon Brown might have the hardest time with credibility as he inherited
previous Treasury Secretary Ken Clarke, who then left Brown with a GBP 17B
surplus in 2000 to squander it into a GBP 33.9B deficit by 2007. In addition,
spending over the same period resulted in public sector productivity declines.
Not a pretty picture for Brown, given conventional thinking is that their
general fix is to cut spending less and tax more, whereas David Cameron and the
Tories would take an opposite view. Mr. Clegg seems to have gone the route of
"open kimono", but differs little from Mr. Brown and the Labour Party
prescription. The difference Clegg has is freshness and a "glasnost" feel about
him, which, added to his good showing in the first debate, has catapulted the
Liberal Democrats to a near vulnerable lead as of this writing. No matter, each
candidate is tainted with the MP expense scandal and so, in the end, it evens
them out.
It would seem that the one who has the strongest claim to
spending cuts might have the advantage, but more so a growth prescription. This
implies the Tories may benefit as they are perceived to have that as their key
tool. The Institute for Fiscal Studies in the UK projects that the Conservatives
might attempt to cut GBP 57 B from the budget, where they forecast the Labour
Party to be at GBP 47 B and the Liberal Democrats at GBP 51 B. The good and bad
of this is that at a high level, they are not very far apart and, should no
majority exist after the May 6 election, it would seem (given that the three are
at most GBP 10 B apart), they can hit a compromise. Should that happen, we could
see the GBP stabilize nicely at 1.50 and see days above 1.60 again.
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