Two Statistics:

• Housing Starts 70% lower than during peak of housing boom
• Surge in Housing starts as new home builds jumps 17%

Both statistics are true. But, both give completely different interpretations. There is a 17% increase in housing starts, but given low basis, it hardly is much to get excited about.

Also note there was an increase at the start of 2009, only for housing starts to drop back again.

The moral of the story is be wary of statistics. We need to look beyond the headline statistic to understand their context and relative significance.

For example, in the UK, we have seen figures like 15% jump in mortgage lending. But, this is from a very low base. Another way of thinking about the jump is. - Despite zero interest rates, mortgage approvals still close to record lows.

After a deep recession, it is tempting to look for glimmers of hope and build them out of proportion, but, they can be misleading.

Unfortunately, recent revisions to GDP statistics suggested the downturn in the first quarter of this year was worse than expected (often revisions go the other way)

N.B. Understanding the significance, context and importance of statistics is an important skill we try to teach Economics A Level students. Another example is the difference between a fall in prices and a fall in the rate of change.

See also: Misleading economic statistics

A report by the IMF suggests that the fiscal cost of the current recession and economic crisis will be dwarfed by the looming demographic timebomb slowly creeping upon many developed countries.

This forecast is the last thing the government will want to hear, given they are desperately trying to juggle the political and social desire to increase spending, with long term fiscal deficits which require some kind of future spending cuts.

e.g. in US, the net present value of the the current recession to 2050 is about 20% of GDP. But, the net present value of an ageing population is close to 700% of GDP. In Britain the cost of an ageing population is around 300% of GDP

I have talked about the demographic timebomb on previous occasions. If I keep returning to it, the reason is that it is liable to prove the defining economic issue of the next few decades. A few startling statistics.

• In 1950, 95 million or 12% of the developed world population was over 60.
• In 2010 that has risen to 269 million or 22%.
• By 2050 that is forecast to rise to 416 million or 33% of the developed world.
• It is almost a tripling of the population over 60. Yet, apart from a few exceptions, retirement ages have increased only by a small amount - if at all.

Source: "World Popultion Prospects", United Nations 2009


Some countries will be hit more than most

The Dependency Ratio defined as population over 65 as % of the population aged 20-64.

	1980	2010	2050
Japan	15%	38%	74%
Italy	23%		74%
US	20%	21%	40%
Britain	27%	29%	46%

Source: "society at a glance" OECD 2009

It is not just a situation related to developed countries, it is also becoming an issue for developing countries like China

This is not to suggest the economic cost of the current recession is a trifling matter, but, what it means is that efforts to reduce the cyclical deficits will prove very difficult as underlying structural deficits play a growing role in shaping government's deficits.

An ageing population should not be a cause of depression. An ageing population is a sign of better living standards, improved health care and longer life expectancy. Improved life expectancy should be welcomed as a major achievement, but, if we expect this increased life expectancy to just equate to increased length of retirement we will let one of the great boons of the modern age become one of the great curses.

Someone will having to be making difficult choices, will the taxpayer be sympathetic?

A slow burning fuse - special report at Economist

The Governor of the Bank of England recently stated that 'if a bank is too big to fail - it is too big.'

I agree with his sentiments of strengthening bank regulation. But, one question is what size bank would be too big to fail?

In terms of public confidence the size of a bank is not that important. Even if the smallest bank like, for example, the co-operative bank went bust, the impact on confidence would be very damaging. Even a small bank going bankrupt could cause a run on bank deposits and cause nervous savers to keep cash under their bed.

The UK's largest bank like Lloyds TSB / HBOS has too much monopoly power (at 31% of market share). There is a good case for breaking up the merger. But, even if it was broken up, would not the two banks still be too big to fail? So when the Chancellor says 'its more complicated than just the size of the bank' he does have a fair point. After all, Lehman Brothers was by no means the biggest bank, but, its bankruptcy is widely seen as a tipping point in the credit crunch becoming very serious.

• Biggest Banks in UK

Moral Hazard and Bank Bailouts

Often economists refer to moral hazard. (see: Moral Hazard and Banks). This is the idea that agents can be influenced to take bad economic decisions. For example, the promise to bailout banks may encourage the banks to take risky decisions in the future. This point is not without merit. The likelyhood of a government bailout could encourage some risky behaviour. However, I think the argument is often overated. Northern Rock didn't pursue its business plan of borrowing on short run money markets because it knew the government would eventually have to bail it out. It pursued its business plan because it really thought this was a short cut to profitability. If the government had said in 2000, - there is absolutely no chance of nationalisation should you you run out of cash, I don't think Northern Rock or any bank would have behaved differently.

Where there is moral hazard is in the bonus culture of many bank executives. As mentioned before pay schemes reward risky - high return investment with no penalty for losing money. This is something banks (if necessary through government regulation) need to address.

Sometimes, free market economists say it's too difficult to regulate banks, banks will just find ways around the regulation. But, this is a lazy approach. Just because bank regulation is not straightforward doesn't mean we shouldn't try. After all, the alternative of hoping for responsible self-regulation has proved to be a total failure.

There are areas where bank regulation can improve. Not least

• - Requiring a certain reserve ratio - especially during boom times.
• - Limiting the % of funding which comes from short term money markets.
• - Regulating bonus culture.

But, note, regulating the size of banks will not solve the problem - alot more is needed

This graph shows the headline inflation rate (in US) and the median inflation rate. The Median CPI excludes those items which show the biggest variation either way. This median rate gives a less volatile inflation rate figure. Although this graph is for the US, it would be a similar story for the UK

Importance of Understanding the Underlying Inflation Rate.

The inflation rate plays a key role in influencing decisions on Monetary and Fiscal Policy.

For example, in early 2008, a spike in oil prices caused a rise in inflation. This rise in inflation encouraged Central Banks to keep interest rates high - just as we were entering a recession. In retrospect this was a mistake.

Now, we are faced with prospect of deflation; but, if underlying inflation trends are closer to 2%, then the case for quantitative easing is less strong.

Also, as we argued here, it is a mistake to give too much importance to inflation in the development of Monetary and Fiscal policy. - Is inflation really so bad?

Graph via: G.Mankiw

Or The Insatiable Appetite for Health Care Spending

When the NHS was formed in 1945, the UK was on the verge of bankruptcy. National debt was over 200% of GDP. Yet, the new Labour government went ahead in creating a universal health care which was free at the point of use. In those early days, prescriptions were free and waiting lists low.

In 1945, government spending on health care was £238 million (or £0.238 billion). This was out of a total government spending of £5.9 bn or 3% of total spending. Since 1945, real spending on the NHS has increased much faster than inflation. Health care spending as a % of GDP has also increased.

Health Care Spending In UK (Nominal Terms)

Health Care Spending Real Terms (adjusted for Inflation)

Health Care Spending as a % of GDP

A few years ago, the government announced large increases in real health care spending. In retrospect this was a spending commitment we can't really afford. Yet, despite this record level of spending. There is still forecasts of a severe spending shortfall of £8-£10 in 2011.

"Having had seven years of plenty it now looks like seven years of famine from 2011 onwards," the NHS Confederation's head of policy, Nigel Edwards, told the BBC. "We are really going to have to think very deeply and carefully about everything we do and subject it to very rigorous scrutiny — and enlist all of our doctors, our front line clinical staff in rethinking the way we do things."

Given the perilous state of UK public finances, there is hardly room for spending increases. From the perspective of public finances, the real spending increases could do with being reversed.

Why is health care spending increasing so much?

• More diseases can be treated.
• New drugs are often expensive
• Increased life expectancy has increased number of old age pensioners who are much more likely to require expensive health care.
• Greater expectations of health care.
  

Solutions to Health Care Shortages

• Reduce number of Treatments from non-essential treatments.
• Ration Expensive Treatments on a
• Allow waiting lists for non-essential treatments to grow again.
• Increase taxes to maintain spending.

From an economic perspective the solution of higher taxes is not desirable. Taxes will have to rise to deal with current structural deficit, without increasing spending further.

The problem is that all solutions are politically difficult. It's one thing to say - ration expensive treatments, but when Aunt Dolly could have her life extended by a few years through expensive treatment it is controversial to deny it.

Yet, just because solutions may be unpalatable doesn't make the problem go away. We come back to the fundamental economic problem (discussed in Econ 1 1st Lesson) - which is scarcity of resources and any choice has an opportunity cost.

Related

• Should We pay to visit the doctor?
• Should we tax unhealthy foods?
  

It is tempting to blame the government of the day for the current economic problems. But, economic problems are often cumulative; some caused by government policy, some caused by absence of government policy and some caused by market forces. Also problems may hit the public consciousness at a particular time. But, the root cause of crisis can stem from the past decade or even longer.

Away from political name calling, there is usually no simplistic answer, and it is unfortunate that debate often seeks simplistic solutions.

When did Our Current Problems Start?

Structural Deficits from mid 1990s.

The US achieved a budget surplus during the latter years of the Clinton administration. This was a combination of fiscal restraint and a booming economy. The US went into deficit after the mild recession of 2001 gave an excuse for large fiscal stimulus.

However, the tax cut during the recession was not reversed during the boom years of 2002-06. The opposite occurred and it was accompanied by spending increases (in particular) on health and defence.

There was a similar situation in the UK. a low public sector debt of 29% in 2003, was turned into a structural deficit as the government decided to increase real spending on health care and education significantly.

The decision to run structural deficits during a boom has made the current deficits more damaging and reduced scope for safe fiscal expansion.

But, a structural budget deficit is hardly the cause of the crisis. The real culprits of the current crisis are the banks and mortgage company who grossly miscalculated what constitutes responsible lending.

A key issue in the UK was the financial deregulation of the 80s and 90s. It is no coincidence that former building societies who became banks pursued the most aggressive and unsustainable lending practices.

There was no particular turning point you can put your finger on. It was a cumulative failure amongst bankers, regulators, analysts and government policy. It was the banks who provided a growing driving force for the expansion of financial instruments. Governments generally went along with the vision of the city. Many were sucked into the ideology of the infallibility of markets. It was an easy philosophy to follow, much easier than trying to fight against.

By 2007-08, the structural weakness was embedded deeply into the system. There was little that could prevent the Tsunami of financial / economic crisis. If the government can be blamed for causing the crisis, they deserve at least some credit for not letting it get out of hand. Mistakes were made, not least the dithering over Northern Rock and bankruptcy of Lehman Brothers. But, it could have been alot worse if different policies had been followed. (see: Crisis Averted)

• Who is To Blame for Credit Crunch?

The Output Gap is the difference between actual Output and potential Output. With a fall in GDP, the UK has seen a rise in its output gap. This output gap is most easily visible with the rise in unemployment to over 2.25 million.

Public sector net borrowing is the annual amount the government has to borrow from the private sector to meet the shortfall between government spending and tax revenue.

As GDP falls, borrowing rises. Tax receipts fall and spending on unemployment benefits increases. The UK budget was particularly hammered because in the boom we increasingly relied on stamp duty from housing market and income tax from the city. With both the city and the housing market hit hard, the government has seen a dramatic rise in borrowing.

Interestingly in the 1981 recession, government borrowing actually fell. This is because of the different circumstances behind the recession.
In the 1970s, government borrowing rose to 8.1% of GDP in 1975 and 7.2% in 1976 (requiring a bailout from IMF). In 1979, the economy faced high borrowing and inflation of over 20%. The incoming Conservative government pursued strict monetarist policies of tight fiscal and monetary policies to reduce inflation. Taxes were increased. This reduced borrowing but caused a sharp slowdown in GDP and a steep recession. In other words the fall in borrowing caused the recession (though some economists would say it was necessary to reduce inflation. Others said the fiscal tightening went on too long to chase money supply targets which proved misleading. For more info see: 1981 recession)

The 1981 recession was different to the current recession because the motive was to remove inflation from the economy; there was no crisis in the banking system like we see now.

UK national debt

Between 1999 and October 2008, UK interest rates were remarkably steady. They varied from a peak of 6.0% in 2000 to a temporary low of 3.5% at the end of October 2008 - just before they were dramatically slashed. This represents an era of great stability and coincidences with a period of low inflation and steady growth. Monetary Policy looked pretty unexciting, and rates rarely varied by more than 0.25%. This apparent stability in interest rate policy of cause masked volatility in credit and housing markets.

Graph of UK Interest Rates since 1990

The outlook for future UK interest rates becomes much more difficult to predict. This is because:

• The effects of Quantitative Easing are yet to be Understood. Even the Bank of England have said the impact of money creation is hard to know at present time.
• On the one hand, many point to the scale of the recession and deflationary pressures. On the other hand others have pointed to the inflationary risk involved in creating money.
• The Banking crisis caught many off guard. Further reposessions and a prolonged recession could exacerbate bank losses and cause more economic turmoil.
• The UK Housing market plays a key role in influencing the economy. Prices have fallen significantly. The question is how much further will they fall?

You could paint two scenarios

Quick Rise in interest rates to 5 - 6%

• The worst of the recession is over. The effect of printing money, zero interest rates, low exchange rate and expansionary fiscal policy will cause an economic recovery and the end of deflationary pressures.
• Record levels of Government borrowing could create inflationary pressure.
• Global recovery is pushing up commodity prices like oil which will feed into inflation
• The impact of increasing money supply combined with a rise in economic activity and bank lending could cause a rapid rise in money supply and inflation.

On the Other Hand You could argue:

Interest Rates Forecast to Remain at 0%

• Quantitative easing is having limited impact because banks just don't want to lend given the state of their finances.
• UK house prices could keep falling another 20% to return house price ratios to long term trends.
• The recession is not yet over and unemployment is likely to keep rising which will diminish wage inflation and inflationary pressure.
• Japan experienced a long period of zero rates after its asset price bubble bust. Even quantitative easing and record levels of debt in Japan failed to cause inflation

OK, time to stop sitting on the fence. - What do I think?

Well, somewhere in between. But I believe we will have slow economic recovery which will create some inflationary pressure. But, I do think interest rates will rise to 3 or 4%. I think we will avoid the Japanese experience of zero rates. But, we live in uncertain times and there is an element of wait and see and then revise your forecasts.

Since the Credit crunch, banks have had an excellent excuse to increase their profit margins as they desperately try to claw back their losses from bad investments in subprime CDOs e.t.c

Firstly, the commercial interest rates have remained much higher than the Bank of England Base Rate. One issue is that if the Bank of England raise interest rates consumers may not see such a large increase on their commercial mortgage.

Commercial Rates and Bank of England Rates

Gap Between Bank Saving Rates and Bank Lending Rates

The gap between mortgage rates and saving rates peaked in December 2008 with a gap of 4.48%. There has been a little improvement during 2009.

This increased gap basically makes banking more profitable.
Another issue is that the merger between Lloyds TSB and HBOS has created more monopoly power in the banking sector. This week the big two banks both announced an increase in their fixed rate mortgages

• Mortgage Rate = Monthly interest rate of UK resident banks (excl. Central Bank) and building societies' sterling standard variable rate mortgage to households (in percent)
  
• Saving Rate = Monthly interest rate of UK resident banks (excl. Central Bank) and building societies' sterling time deposits households
  

Evidence from the US suggests that the US rice fall have reduced house prices close to or lower than pre-boom levels.

Looking at the ratio of house price to incomes and the ratio of house prices to rent the gains of the boom have been wiped out.

• Note: These figures are upto the end of 2008, but, house prices are still falling in 2009 and could keep falling into 2010
• The important thing is that the Housing Market can by its nature be Volatile. In other words booms in prices are too big; but, house price falls can be overdone too. This is because of the momentum effect in driving house prices higher and then driving house prices lower.
  

Ratio of House prices to Incomes in US


source of graphs: Calculated Risk

Ratio of House Prices to Rent

This has potentially important consequences for the UK. In recent months, evidence suggests house price falls have begun to stabilise. But, although house prices have fallen significantly from their peak in mid 2007, the ratio of house price to earnings is still relatively high.

The current ratio of house price to incomes is about 4.0. (down from over 5.1) But, less than the lows of 2.5 we saw at the end of the last bust in 1993 (source: Ratio of House price to Incomes)

Why Have US House prices Fallen so Much?

1. Extent of the recession. The recession has been much more severe than previous recessions making demand for houses fall

2. Extent of the Banking crisis. This has severely limited bank lending which is essential for feeding the mortgage market.

3. Negative Momentum Effect. When house prices are falling, it creates a negative momentum effect causing prices to keep falling. (it's a very different market to stocks and shares where it's easy to buy when you think there are bargains.

When house prices are falling, sentiment towards buying remains negative giving people incentives to 'wait and see'. T

Differences Between UK and US Housing Markets

In some respects the UK is different to the US experience. In our house price boom we didn't have a boom in the building of new houses. In the US, not only are people not buying but there is a large stock of unsold houses putting more downward pressure on prices.

In the UK, people may not be buying but there is not this excess capacity that pushes prices down so much.

Also, whilst the recession has been very deep. Interest rates are also at record lows. For those who can get a variable mortgage, buying a house looks more attractive than renting.

If the house price fall did come to a halt, then house prices would still be relatively expensive and out of the reach of first time buyers.. With this ratio of house prices it would be hard to see another boom. We could see a few years of stagnant house prices (which in itself would be no bad thing) However, if we were to repeat the experience of early 1990s when Real house prices (adjusted for inflation) fell much further or if we were to follow US house prices, we could be looking at another 12-18 months of house price falls.

If house prices look cheap now, there may be even better bargains in 2010.

Many worry about a large rise in Government borrowing during a recession. There are still analysts who will say it is irresponsible for government borrowing to rise sharply in a recession. However, to look at government borrowing is to examine only part of the equation. It is important to look at overall borrowing and saving.

The important principle of government borrowing in a recession is that it offsets the fall in private sector borrowing. The government borrows to offset the fall in private sector borrowing and spending.

During a recession, consumers become risk averse; rather than take out loans they seek to pay back loans. For example, this year, more mortgage debt has been paid back than taken out. This fall in private sector borrowing (and corresponding rise in private sector saving) can be very sharp causing a potentially dramatic fall in aggregate demand and economic output. If the government maintained the same fiscal position, there would be a sharp fall in output.

This graph shows the inverse relationship between private borrowing and government borrowing in the US.




Also the fact that private saving rises means there is greater appetite for buying government debt and therefore 'crowding out' and higher interest rates are unlikely to occur.

The difficulty is when the economy recovers and private borrowing starts to rise again. As the economy recovers the government need to reduce borrowing. If government borrowing remains very high when private borrowing is also high, - that is when we will get difficulties of financing the deficit / crowing out e.t.c.

Government Borrowing in a recession is a necessity. The larger the fall in private borrowing the larger the rise in government borrowing needs to be. (Rules like the EU growth and stability pact become a nonsense in a recession like this)

The difficulties will come in 2010, 2011 if the economy recovers and the government is unable to reduce its borrowing. To increase government borrowing is politically much easier than to reduce borrowing. But reducing borrowing (when circumstances dictate) is just as important as the borrowing.

• UK National Debt

Often people ask me how does government borrow money and who does it borrow from?

Or How to Borrow £220,000,000,000 in a year and keep smiling...

The Bank of England used to be responsible for selling UK government debt. But, now that responsibility is undertaken by the Debt Management Office DMO (part of the UK Treasury)

Given the eye watering figures involved this year, (the DMO will need to raise around £220bn) their job has been made more interesting to say the least... Nearly every week the government is having a gilt auction, where they sell gilts either directly or indirectly to intermediaries who sell on the government's behalf.

The Debt Management Office sell a range of financial securities which are basically loans or I O Us. These bonds have a fixed interest payment. e.g. a £1,000 bond may have an interest payment of £50, giving an interest rate of 5%.

The most common type of debt is a long dated gilt. These have a maturity of say 30 years. They are often bought by pension funds and investment trusts looking for a guaranteed return over a long time. These pension funds are typically UK based funds, but, also include foreign buyers.

Increasingly popular are index linked bonds, this means the interest payment is fixed to the rate of inflation to ensure the real value is maintained.

Because the DMO has to sell so many bonds, they are keen to attract foreign buyers. Foreign buyers are often more attracted by short term gilts which reach maturity in a short time - 3 months, 1 year e.t.c.

A Rating Downgrade would make it more difficult to sell government debt - especially to oversees investors. A rating downgrade or genuine concerns over the UK's ability to repay would lead to investors requiring higher interest payments to compensate for risk.

After a failed gilt auction in March, recent gilt auctions have been oversubscribed - this will come as a relief for UK treasury, but, there is still a long way to go and the Treasury will be hoping demand for UK government debt will remain strong.

At the moment certain factors make the job of the Debt management office easier in selling debt.

• Low interest rates, mean the interest rate on government bonds is relatively low. This means the cost of servicing debt is relatively low. If interest rates rose, the cost of servicing national debt could in itself increase the borrowing requirement.
  
• Recession makes commercial bonds unattractive, therefore, investors are keener to go for the perceived security of government bonds.
• The Bank's policy of quantitative easing - buying a range of bonds, increases demand for government bonds and this increased demand makes it more attractive to buy bonds in an auction.
• The UK's fiscal position, although bad, is comparatively not as bad as many competitors, therefore there is still foreign demand for government bonds - despite threats of rating downgrades.

What Could make selling debt more difficult in Future?

• If the economy didn't recover leading to a worse fiscal position than expected.
• More bank losses which government need to absorb.
• An end in quantiative easing would reduce demand for bonds
• Rising interest rates would make it more expensive to buy.
• Threat of inflation and devaluation of pound would make foreign investors want to leave UK

Related

• National debt from a historical perspective
• Government borrowing in recessions
• UK National Debt
  

• Tentative signs of economic recovery. and Oil prices resumes their rollercoaster ride.
• Warning over getting carried away by recovery as unemployment rises
  
• Efficient Market Hypothesis - The idea that markets will correctly predict stock prices and avoid irrational decision making. Needless to say the great recession has punched another hole in this theory. Yet, there are still some who try to maintain markets will rationally and correctly price stocks. See also Psychology of bubbles
  
• How Will sustained government borrowing impact on Economic Growth? - An interesting question. Note sustained government borrowing is different from cycling borrowing in a recession. It seems this is an issue most developed countries will have to face in the 'hangover' of the great depression.
• A British Bounce ? - (P.Krugman blog) There are signs that the bold economic policies has enabled the UK recovery to be better than our EU counterparts.
  

Causes of Sovereign Debt Crisis Include:

1. Government Borrowing.

High government borrowing often leads to selling bonds to oversees investors. (frequently foreign investors make bad judgements and buy debt from countries who later default.)

2. Bank Loans in foreign currency

If domestic banks take on foreign debts they become liable to repay them in foreign currency. For example, in Iceland, between 2001 and 2008 the three major banks hold foreign debt in excess of €50 billion, or about €160,000 per Icelandic resident, compared with Iceland's gross domestic product of €8.5 billion

3. Bad Debts in Banking system

If you hold this volume of foreign debts and the debtors start to default you lose substantial sums.

Solutions to Sovereign Debt Crisis.

Reduce Budget deficit.

With a sovereign debt crisis, the government will probably be unable to sell government bonds to foreign investors. For example, in June 2009, Latvia failed to sell a single bond at a government auction Reducing the budget deficit will mean the government need to sell less bonds.

• However, draconian spending cuts could cause a deep recession. e.g. in 2009, the UK has a forecast budget deficit of 12% of GDP. To reduce this deficit would require a huge tax rise and spending cuts.
  

Devaluation

A devaluation in the currency means it is easier to pay foreign debts.

• The problem is that a sharp devaluation means foreign investors will want to flee the country as they will lose money. Also the devaluation will cause inflation and economic instability.

IMF Loans

Loans from the IMF or body like the EU, can enable the country to meet current debt obligations. This can provide a short term breathing space and help restore confidence.

• However, it doesn't address the underlying structural problems.

It can inflate away the debt.

Printing Money can reduce the nominal value of the debt and make it easier to pay the debt, but, it will cause inflation and devalue the exchange rate.

Other Debt Crisis

• Latin American Debt Crisis
• Asian Financial Crisis
  

Sovereign debt is the debt a government owes to people outside the country. (e.g. foreign banks or foreign investment trusts who bought government bonds)

If a private firm defaults on debt you can pursue the debt default through legal means. But, when a foreign country defaults, there is usually no legal recourse of action.

Usually, governments are seen as reliable debtors because their track record shows no debt default. However, certain developing countries have defaulted on debt payments causing

Sovereign Debt

If a country has debts issued in its own currency. e.g. US sells bonds denominated in dollar. If the US ever struggled to finance its debt it could print more money to inflate away the debt. This would create inflation and discourage future investors.

Sovereign Debt in Foreign Currency.

The problem is more severe when a country owes money issued in a foreign currency.For example, Icelandic banks took on many foreign mortgage debts.

Latvia has many bonds issued in Euros. Therefore when the bonds are due for repayment they need to find the foreign currency to pay their debt obligations.

For example, Latvia faces a sovereign debt crisis because according to Fitch Ratings foreign debt maturing in 2009 is equal to 320pc of foreign reserves. (e.g. Latvia holds many euro, Swiss franc, and yen mortgages.) It owes more foreign debt than it has foreign currency.

Is the UK Facing A Sovereign Debt Crisis?

• UK government debt has increased sharply (12% of GDP this year). There is little chance of an improvement in public finances in the medium term without imposing painful choices on government spending and deflating the economy.
  
• Quantitative easing could create inflation and devalue the Pound making investors want to leave UK.
  
• S&P rating agency said it was likely to downgrade UK's triple A credit rating.

However,

• Comparatively, the UK is not exceptionally bad.
• Some countries like Ireland and Spain have already had their credit rating downgraded.
• A small downgrade from triple A rating is still a long way off a rating of CCC we see in the likes of Latvia and Ukraine
• If investors flee the UK where would they go? - nearly all major OECD economies are facing high levels of public debt, recession and possibility of devaluation. The recession is as bad, if not worse, in other major EU economies.
  
• The recent appreciation in the Pound shows the markets have some relative confidence in UK