British General Election: Even the Winners Will be Losers

[Editor's Note: In the article that follows, U.K. native Martin Hutchinson, who correctly predicted the outcomes of the 2008 presidential primaries and general election, handicaps Thursday's British general election in which Gordon Brown's Labour Party faces David Cameron's Conservatives and Nick Clegg's Liberal Democrats.]

The British general election campaign reaches its climax on Thursday, and at this point appears to be anybody's game. The most likely outcome is a "hung parliament" in which no party has a majority and a government is formed through backroom haggling.

However, after looking yet again at the state of the economy in my native Britain, I'm forced to ask a simple question: Why would anybody want the job?

Great Britain: 2008 BC (Before Crisis)

Until 2008, the British economy looked to be in decent shape. It suffered badly in World War II, and then failed to enjoy the same postwar growth as France and Germany because its taxes and government spending were way too high. The simultaneous financing of a free National Health Service and a vast-and-rebellious imperial overhang during the 1950s and 1960s was impossible.

As the British Empire was abandoned and cutbacks made there, the National Health Service and the expansion of university education ate up all the savings. After 1979, however, under Prime Minister Margaret Thatcher, significant free-market reforms in labor law and privatization, together with fairly minor cutbacks in the state sector, produced a much-healthier economic picture.

The early 1990s were painful years for Britain, partly because the attempt to link the pound to the German mark in 1990 made the economy very uncompetitive for two years and required interest rates of 15% to sustain it (as a London homeowner during that period, I still bear the scars - British mortgages are floating-rate!).

Once the pound was allowed to float (downward) in 1992, however, the economy never looked back: From 1992-2007, Britain had the best-sustained growth in Europe.

Two problems remained.

First, even in the 1990s, Britain had again become sloppy about public spending. Spending was allowed to increase, and the increase accelerated after 2000 as the Labour government elected in 1997 settled in and started implementing its wish list.

British public spending - which had bottomed out at around 38% of gross domestic product (GDP) in 1989, Thatcher's last full year - would actually exceed 50% of GDP by 2009. What's more, tax revenue was allowed to fall behind, so that in 2007-2008, a boom year, Britain still ran a budget deficit of 5.3% of GDP.

The other problem was that the economy became increasingly dependent on revenue from the City of London financial district, which developed into a kind of offshore island with very little connection to the rest of the economy. This was partly because London housing prices had zoomed into the stratosphere (the London house that I sold in 1994 for three times what I had paid in 1984 was worth four times that sales price by 2007).

Needless to say, with inflation fairly modest, incomes in 2007 were not 12 times what they had been in 1982. Except in the City. There, even more than on Wall Street (because they started much lower), incomes had gone through the roof. Unfortunately, only Brits earned a modest proportion of those incomes.

In the aftermath of a poorly designed deregulatory push in the middle 1980s, the British merchant banks had been bought out or had gone bust and almost all London banking was controlled from either Wall Street or continental Europe.

Naturally, most of the bankers - like "Fabulous Fab" of Goldman Sachs Group Inc. (NYSE: GS) - weren't British, either. Even more annoyingly, they didn't have to pay British tax, because they could pretend to earn their income outside the country. Add in a sprinkling of Russian mafia and Arab oil sheiks also attracted by the tax benefits - and a mass of impoverished immigrants attracted by generous social benefits - and you had a society in which there was huge inequality and very little in the way of domestically generated productive endeavor.

Needless to say, that's why there's a problem now.

A Tough Road

The British budget deficit is considerably larger than that of its U.S. counterpart. In fact, at about 12% of GDP, Britain's budgetary shortfall is now nearing Greek territory. The City of London looks much less likely to sustain the entire economy going forward - the financial-services business itself may get smaller, and there is now little reason why it should not move elsewhere.

House prices in Britain haven't fallen as far as they have in the United States, which could well mean that there are more huge losses to come in the housing-finance sector.

Various social pathologies have been encouraged by the last 13 years of politically correct public spending, so the forces that should produce an entrepreneurial revival here in the United States may prove too weak to prevail in Great Britain.

There's a second difference whose impact is worth noting. In the United States, a mere year of government expansion has produced a huge political backlash. In Britain, the expansion of government was twice rewarded with thumping election victories - one in 2001 and the other in 2005. Only now, when disaster has occurred, is there any possibility of change - and even now there's no certainty of it.

Bank of England (BOE) Governor Mervyn A. King recently said that the party that wins this election would become so unpopular because of the policies it was forced to introduce that it would be out of power for a generation.

I tend to agree. As a young lad, I wanted to become prime minister (until my student electoral record of zero for 32 (0-32) told me that I'd better shift my career aspirations into banking...). However, even if I were guaranteed the chance to achieve my dream, I wouldn't want to take over right now: They could offer me full dictatorial powers and a guaranteed 10-year term, and I'd still turn it down.

Prime Minister Thatcher turned the British economy around in the 1980s. But today's problems are much worse, and the solutions far more painful - so painful, in fact, that any reformer would get tossed out of office after one term, after which all the "reforms" would get reversed.

That brings us to the eventual outcome of this long and painful story. The probability of an eventual British default on debt must be quite high - and since Britain is not a member of the euro, there would be no bailout.

[Editor's Note: With Martin Hutchinson, Money Morning readers have seen it time and again - the kind of creative, profit-focused thinking that's allowed him to succeed again and again where other experts have failed - one right after the other. And Hutchinson has pulled off this string of successes in the face of the worst financial crisis since the Great Depression - a financial crisis that, not surprisingly, Hutchinson is widely credited for having predicted and warned about well ahead of time.

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With his "Alpha Bulldog" investing strategy - the crux of his Permanent Wealth Investor advisory service - Hutchinson has managed to combine dividends, gold and growth in a winning formula that has developed eye-popping returns for subscribers. To find out more about opportunities related to dividends, gold, "Alpha-Bulldog" stocks and The Permanent Wealth Investor, please click here.]

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