U.K. ETFs Are Not A Buy

by: Alan Longbon


Government sector planning to drain the private sector of 10B GBP per year.

100B+ GBP out flows from the external sector per year.

Foreign direct investment and capital flows the only light on the horizon.

This is another in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe.

The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.

In this article, we examine Britain from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward.

Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.

The magic formula for success is:

P = G + X

And you can read more about that below.

Which Countries Are Doing Well?

The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.

The chart is from early December 2016. In that time positions have changed a little as the table below shows.

Most countries on the list are in the red and are of no further interest, though we could learn from them what to avoid, as could their governments and politicians. But, as investors, we will leave that to them. We are getting to the bottom of the list of countries that are doing well and so they are not so good.


Since the start of this series of articles, Britain has moved from 35 to 28 on the list and is up 11% over the last 12 months.

We will start the analysis with the government sector.

Government Sector

The following extract from the last British budget sets out the fiscal plan going forward:

"Significant progress has been made since 2010 in fixing the public finances. In 2009-10, the government borrowed around £1 in every £4 it spent. In 2015-16 the government is forecast to borrow around £1 in every £10 it spends, and this is expected to reduce to around £1 in every £14 in 2016-17.39

The deficit as a share of GDP is forecast to be cut by almost two-thirds from its 2009-10 post-war peak and will reach 3.8% of GDP in 2015-16.40 The government has addressed the rapid rise in public sector net debt (PSND) which more than doubled as a share of GDP between 2007-08 and 2011-12. Net debt as a share of GDP is forecast to fall over this Parliament, reaching 77.2% of GDP by the end of 2019-20.41

The public finances would be in a much worse position had the government not undertaken the fiscal consolidation that has occurred since 2010. Analysis in Chart 1.5 shows that the government would have borrowed an additional £930 billion over the period 2010-11 to 2019-20 compared to the outturn and the OBR forecast.42 This is calculated as the path of public sector net borrowing if cyclically adjusted public sector net borrowing (the structural deficit) had been fixed as a share of GDP since 2009-10 at its 2009-10 level. The chart shows the cyclical improvement in the economy since 2009-10 which would have reduced public sector net borrowing from its post war peak of 10.3% of GDP. However, the persistence of the structural deficit means that borrowing would have been higher in every year from 2010-11.

However more work needs to be done - the deficit and debt levels are still too high. The government remains committed to continuing the job of returning the public finances to surplus by 2019-20 and running a surplus thereafter in normal times so Britain bears down on its debt and is better placed to withstand future economic shocks. In a low inflationary environment, with the risk of economic shocks, the only reliable way to bring debt down as a share of GDP is to run a surplus....

...This Budget sets out the action the government is taking to meet the fiscal mandate, achieving an overall surplus of £10.4 billion on the headline measure of public sector net borrowing in 2019-20 and a surplus of £11.0 billion in 2020-21."

(Source: HM Government budget 2016)

The budget is steeped in neo-liberal debt obsession. Nearly every paragraph parrots the debt reduction must have a surplus mantra. One must remember that the government's surplus is the non-government sector's loss.

The ultimate government plan is to reach a level where it is draining 10B GBP out of the private sector each year. The whole budget is dedicated to this aim, and I have not read a budget so singularly dedicated to the drainage of the private sector as this one while writing this series of articles. When one adds the external sector drainage, covered later in this article, to the government sector drainage, the private sector looks to be in an extremely challenging position going forward.

There appears to be no hope from the other side of British politics either. The Labour party follows largely the same neo-liberal narrative. Their distinguishing feature is that they will not be so cruel at doing it.

The chart below shows the government budget picture.

The British government has been a net add to the private sector long-term.

The chart shows the familiar pattern of decreasing deficits heading into a boom-bust, recession and a return to larger deficits as the automatic stabilizers deploy to catch all the people who's job disappeared in the downturn.

If the deficit cuts and surplus budgets had not taken place, the downturn would either have not occurred or been less severe because aggregate demand would have been maintained. Capitalism runs on sales and sales are income.

The explicit government plan to achieve a surplus in 2020 and the current declining trend in deficit spending puts the next recession only two to three years away.

The next chart shows the value of the budget and a measure of how much money is added or drained from the private sector by the government sector.

The chart shows that the government has net added to the private sector but has often also drawn money out. The huge surplus in 2006-7 would have helped make the GFC boom-bust much worse than it needed to be. Right at the time the economy was reaching a peak level of transactions and needed as much liquidity as possible the government removed 40000 GBP million out the private sector over four consecutive quarters. Madness.

Britain has the following tax rates:

(Source: Trading Economics)

The rates of taxation are relatively high and skewed heavily for business with a 20% corporate tax while the wage earners are paying a 45% top marginal rate plus a 20% consumption tax on all they buy. The financial misery of the consumer goes on with the likelihood of a very high mortgage with which to afford his overpriced accommodation as the chart below shows.

The chart above shows that the cost of housing has increased eight-fold since the 1980's and took off after 2002 to peak in 2007 and then again in 2017. Despite the relatively high home prices, the rate of construction has not slowed much as the chart below shows.

The dream of home ownership is well and truly over in Britain as the chart below shows.

A return to a feudal system of land tenancy is now in trend. A nation of renters paying rent to a long established landlord system that began with the enclosures by Henry VIII in the 1600's. One rents or becomes a debt serf.

The chart below shows that the debt to income level is high and beginning to rise again after the peaking in 2009 and bottoming in 2014. Given how high home prices are the debt is large in absolute terms as the family home is the biggest form of debt financing.

The British government is the sovereign issuer of its currency unit; as the source of all money in the economy it does not need to obtain funding from the private sector via taxation or borrowing. This sort of economic thinking shows that the government is acting as if the gold standard still exists and that its spending needs to be squared off against a fixed quantity of gold; this has not been the case since 1971.

One must ask where does the debt mantra come from? The debt mantra comes from the self-imposed constraint of issuing a government bond at interest whenever the government spends money into the economy.

Fact: Federal government spending is in no case operationally constrained by revenues, meaning that there is no "solvency risk." In other words, the federal government can always make any and all payments in its own currency, no matter how large the deficit is, or how few taxes it collects.

(Source: Warren Mosler)

The British government budget paper uses the term borrowing to refers to its spending as if it were a foregone conclusion that the money would be borrowed and not created as more medium of exchange is required to be added to the system as it expands. If the current "borrowings" were paid back in full, there would be no money in circulation as it is all 'debt.'

The budget papers paint a picture of a government that is not aware of its currency creation powers, is obsessed with debt and driven by a now redundant gold standard budgeting mentality, and is unaware of its role as the provider of the medium of exchange. There is a belief system in the financial and government system that will take generations to undo and has barely started.

This sort of gold standard thinking is further reinforced by Britain's 'half' membership in the EU. In the EU the full members have given up their sovereign currency creation powers and are now the users of the Euro and really must borrow from the ECB at interest to fund themselves. The debt is real. The EU is the private bankers dream fully realized. Nations states in thrall to private bankers.

Britain, on the other hand, retained its currency sovereignty and has voted to leave the EU. Leaving the EU also means leaving the debt mantra culture, the three percent fiscal compact and other artificial budgetary mechanisms with the focus on inflation control and little regard to unemployment.

The Southern European States\countries can have great depression level unemployment, and that is alright so long as inflation rate and bond yields are low.

By leaving the EU Britain has a chance to throw off the redundant gold standard thinking debt culture mantra and embrace modern monetary thinking and prosper.

Taxation that dampens aggregate demand and creates enormous and unnecessary collection dead-weight losses could be dropped and that resource more productively allocated.

Fiscal policy that is hemmed in by self-imposed constraints, such as bond issuance, expanded by dropping those artificial restrictions.

Expanding the money supply, debt free and not at interest, within the limits of set inflation, employment and currency exchange rates could begin. This is a far more intelligent basis than the current "old think."

Given how deeply ingrained this debt mantra is, plus the feudal landlord culture, this is highly unlikely to happen. Landlords and bond holders can rest easy and collect the unearned income for many more years to come. Seed for change will find stoney ground in Britain.

External Sector

The chart below shows the long-term balance of trade position.

The chart shows Britain has a poor balance of trade position and that it is trending worse rather than better.

Regarding real goods, though, Britain is materially better off as it has traded computer credits for real resources. Computer credits are in infinite supply whereas real assets are finite. Britain is materially better off but financially worse off.

The chart below shows the capital flow situation.

The chart shows that capital flows are a net positive and have been since the 1980's and reflects the City of London's status as a global financial center. After peaking in 2014, the trend is now downwards. How Brexit will impact on future capital flows is not clear however they are unlikely to improve.

The chart below shows foreign direct investment.

Foreign direct investment is a positive picture and shows net inflows since the early 1990s. FDI shows that foreign business people are investing in Britain and see future profits and growth there. This is a strong vote of confidence.

The chart below shows the current account situation.

The current account pulls it all together and shows that when one considers the external sector's total impact, it is large and increasing financial drain on the private sector. This situation is unlikely to change as there structural and geographic reasons why the trade and fund flows are what they are. As stated before Britain is materially better off and can create as much computer currency credits as foreigners are willing to hold.

The government sector has the stated aim of wishing to drain the economy of 10B GBP per year by 2020. The existing drain from the external sector on the private sector is 108B GBP per year (2016). This makes a total drain of some 120B GBP per year if present trends and plans remain in place, though one notes the current account is trending to further deterioration and so the number is likely to be more and not less.

So where can this 120B GBP per year come from? Private debt.

The private sector will go into further debt until there are no more creditworthy borrowers left who are ready, willing and able to take out a loan. At this point, aggregate demand will collapse, as it did in 2007 and another recession will come.

A government that is running a country that is being drained by the external sector cannot also afford to drain the private sector with surplus budgets. The opposite is true. Such a government needs to be injecting money into the economy to match the external deficit PLUS more to grow the economy and enable people to save and invest.

Total Trend

One can see the whole trend when one compares GDP with the amount of money in circulation, shown in the following two charts:

Both charts show an upwards trending growth profile overall, though GDP has fallen in the last year and the money supply has been largely flat since 2010 with a small return to growth in 2016.

GDP has fallen of late, and the money supply has risen. This should lead to inflation, and the chart below shows that this is indeed the case.

The inflation rate is creeping higher after many years of decline. At less than 2% it is still low by any standard. This means the British government has fiscal space to create more currency and spend it into being on public health, education, and infrastructure or lower tax rates or both. Lowering tax is a good deal easier than making and building things and can have an immediate impact. This would be popular too as the average consumer is highly taxed and loaded with debt.

Britain enjoys a high and growing employment rate as the chart below shows. Britain proves that one can have high employment and low inflation, even deflation at the same time. Economic thinking that says you can have one and not the other is clearly false; you can have both at once. NAIRU, the Phillips curve, and the Laffer curve have no place in Britain; in fact, Britain debunks them roundly.

One can achieve inflation in two ways. One is positive in that the government puts too much money into circulation and the other is negative in that the economy shrinks and produces less while the money supply rises or stays the same. Greece is an excellent case of the latter.

Sectoral Analysis Methodology

Each nation state is composed of three essential components:

  • The private sector
  • The government sector
  • The external sector

The private sector comprises the people, business, and community, and most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, it needs income from one or both of the other two sectors to grow in value.

The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes.

The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained, for a sovereign government with a freely floating exchange rate any financial constraint such as a matching bond issue is a self-imposed constraint. A debt ceiling is also a self-imposed constraint.

The external sector is trading with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.

One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.

For the stock market in the private sector to prosper and keep moving upward, income must enter the flow. Otherwise, the sector can only circulate existing funds or is being drained of funds and is in decline.

The ideal situation is that the private sector has a net inflow of funds and is constantly growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.

The following formula expresses this simple relationship.

Private Sector [P] = Government Sector [G]+ External Sector [X]

P = G + X

For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.


Britain is not a buy. Our assessment criteria are not met in that both the government sector and external sector are (or plan to) draining funds from the private sector and this is finding expression in slowing GDP growth and rising private debt levels.

When one looks at the sustainability of the income flows one can read that the government has single-mindedly dedicated itself to draining the private sector as soon as possible of 10B GBP per year. External flows will drain some 110B GBP per year out of the private sector, tendency rising.

If an investor believes that the British government will see the error of its ways and suddenly develop an understanding of basic national balance of accounts sectoral accounting and begin injecting 120+B GBP per year into the private sector then the following ETFs will be of interest:

  • iShares MSCI United Kingdom ETF (NYSEARCA:EWU)
  • iShares Currency Hedged MSCI United Kingdom ETF (NYSEARCA:HEWU)
  • First Trust United Kingdom AlphaDEX Fund (NASDAQ:FKU)
  • iShares MSCI United Kingdom Small-Cap ETF
  • WisdomTree United Kingdom Hedged Equity Fund (NASDAQ:DXPS)
  • Deutsche X-trackers MSCI United Kingdom Hedged Equity ETF (NYSEARCA:DBUK)
  • SPDR MSCI United Kingdom Quality Mix ETF (NYSEARCA:QGBR)

The next article takes us across the Channel to France, a country very much in the news lately.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.