The economy of the United Kingdom is facing an unprecedented existential crisis, where even the prestige of the Crown is unable to halt the free fall of the country.
The accumulation of structural problems and flawed policy handling has brought the United Kingdom to a critical tipping point.
A sequence of just five critical stages now separates British society and economy from absolute collapse.
According to Neil Record, former principal economist of the Bank of England, meaning the central bank of England, British Chancellor of the Exchequer John Healey faces an unenviable task.
The scale of the challenge was highlighted during the current week, with borrowing costs of the United Kingdom surging to exorbitant levels.
According to data from LSEG cited by Reuters, the yield on the British 30-year gilt reached up to 6.029% on Thursday, marking its highest level since January 1998.
At the same time, the yield on the 10-year rose to 5.510%, a level not recorded since July 2007, while yields on five-year paper also registered a significant increase.
Debt in absolute terms stands just below 3 trillion pounds (approximately £2.99 trillion, roughly 3.6 trillion euros), while as a percentage of GDP it amounts to approximately 94% to 95% of the GDP of the country.
The truth is that investors financing the borrowing addiction of Britain have reason to be wary.
Andy Burnham, the Prime Minister, insisted last week that the United Kingdom is «excessively exposed» to bond markets, months after declaring that it «is in thrall to them».
However, it is his own words that have amplified that exposure.
The position of the Prime Minister in the House of Commons that social security is a higher priority than national security left investors deeply unsettled.
Gilts (government bonds) represent the dominant source of financing for the fiscal deficits of the country (and, consequently, of the debt).
Approximately 33% of investors in gilts are foreign; they may not follow the economic and political life in the United Kingdom in detail.
They may rely on broader assessments regarding the prospects of the country.
Therefore, statements by senior political officials carry weight.
When bond markets panic, it can push into economic crisis a nation situated in as precarious a position as the United Kingdom.
Consequently, if a catastrophic collapse were to occur, this is how the most extreme scenario could unfold.
Step one: Oil price shock
It could begin with a shock. For example, Saudi Arabia cutting (or completely halting) its oil exports following an attack by Iran on a pipeline.
This constitutes an exceptionally probable and immediate danger.
Oil prices would rise to 150 dollars. Further increases would not be ruled out.
The United Kingdom, particularly exposed to international energy prices, sees inflation surging within a few months to 6%.
The government proceeds with its fiscal plans by levying new taxes on top earners and the wealthy.
It pledges to spend all this money and even more on welfare programs, energy price supports, and the much-touted devolution plans of Burnham.
Meanwhile, in reaction to the oil shock, bond markets across the world panic, but particularly in the United Kingdom.
Yields on 10-year gilts surge to 9%, inflicting heavy capital losses on existing holders of approximately 30%.
Step two: US and EU curb spending, Britain does not
The USA announces an emergency package of spending cuts, thereby restoring confidence in the American bond market.
Most EU member states follow suit, but the British government remains unmoved.
The pound, which had remained stable for a prolonged period, begins retreating against all major currencies, and foreign holders of gilts see their losses mount to 50%, the result of a combination of continuously rising long-term interest rates and currency depreciation.
An astute journalist identifies that the collapse in gilt prices has left the Bank of England facing more than 100 billion pounds in additional potential losses, far greater than previously recognized, from the bonds it purchased under the quantitative easing (QE) programme.
Taxpayers will have to cover these losses.
This revelation rattles the already shaken gilt market, and the next government bond auction fails to clear.
In other words, there are not enough investors submitting bids to purchase all the bonds on offer.
Step three: The British government runs out of money
Meanwhile, the Monetary Policy Committee of the Bank of England raises interest rates by whole percentage points at a time, trying to confront the escalating crisis.
Interest rates have now reached, potentially, 10%.
The housing market collapses, but transactions are so few that it is difficult to assess the magnitude of the fall.
For the first time in three decades, instances of negative equity are everywhere.
This means homeowners owe more on their mortgage than the value of their property.
Banks begin warning of mortgage defaults, which causes turmoil in stock markets as well.
The failure of the government to auction government bonds (gilts) confronts it with a dilemma.
It can proceed with even higher interest rates, so as to offer gilt investors a worthwhile return, but in doing so risks a full collapse of the housing market and massive corporate bankruptcies.
Or it can risk having to fund the fiscal deficit and maturing bonds largely by printing money, with the danger of triggering an inflationary vicious cycle.
The fiscal deficit has already ballooned due to higher interest rates and declining tax revenues from the weakening economy, and now stands at 250 billion pounds, or 8% of GDP, with no indication that its growth is slowing down.
Inflation now surpasses the 10% threshold and, unlike 2022, continues to climb upward.
The surge in prices of imported food, goods, and energy leads to widespread public sector strikes, as workers demand higher wages to offset the rise in the cost of living.
The pound, which had traded in the range of 1.20 to 1.40 against the US dollar for so long, drops below parity and then to 0.90 dollars.
Step four: Political chaos and gilt default
John Healey, the Chancellor of the Exchequer, resigns, and Prime Minister Andy Burnham quickly follows.
The outgoing prime minister had fatally failed to call an election, despite pressure from MPs of his party, citing their resistance to having the country governed by capital markets.
Angela Rayner is elected leader of the Labour Party.
Subsequently, the government fails to pay the interest and principal (the initial amount) due on a maturing gilt, because no British bank is willing to provide emergency financing.
As a result, markets essentially lock the United Kingdom out of the gilt market.
Trade unions call a general strike (though this call is largely ignored).
The pound retreats to 0.70 dollars against the US dollar, while inflation climbs to 25% and continues rising.
Step five: Collapse of society and the economy
Rayner is forced to call an election.
The election results not only in incidents of violence and intimidation at polling stations, but also in a hung Parliament, with no clear majority for any party.
As time is critical, the King intervenes and calls upon the leaders of the four largest parties to agree to the formation of a «wartime-style national government coalition».
The Cabinet would consist of party members in proportion to their parliamentary representation in the House of Commons.
This coalition agrees to drastic cuts in public expenditure, including freezing state pensions and welfare benefits instead of raising them in line with inflation.
In parallel, it cuts public sector employee pay by 15% and lays off 200,000 civil servants.
However, under mounting pressure from trade unions and public sector strikes, the coalition collapses.
Social unrest erupts in multiple cities.
Aftermath
If we arrive so deep on the path toward economic, political, and social chaos, who knows where the situation will end and what the day after will look like?
Similar crises in other nations have led to dictatorship, often involving the military.
In other instances, inflation has spiraled out of control, reaching very high double-digit or even triple-digit rates.
Rarely do nations emerge from such a collapse with renewed momentum and confidence.
If you consider it an exaggeration how high interest rates could climb, in October 1976 the Labour government, amid the crisis of that era, was forced to issue a 22-year gilt with a fixed interest rate of 15.5%!
And if you believe there are limits to how high interest rates can reach, think again.
In the overnight interbank market, on the evening before the forced exit of sterling from the Exchange Rate Mechanism (ERM) on September 16, 1992, sterling rates reached 3,000% (yes, you read correctly, three thousand percent).
How exactly Parliament and other institutions would react to such a crisis is, of course, impossible to know until it occurs.
Yet the United Kingdom sits far too close to economic collapse for comfort, and I do not believe the current government is treating the threat with appropriate seriousness.
If our Prime Minister can argue that social security is more important than national security, he may also believe that social security is more important than financial security.
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