However, both Horatio Nelson and Mr Brown share a physiological anomaly: a glass eye! Nelson was famous for ignoring orders from his superiors, and justified his actions, to his subordinate, by placing his telescope over his false eye and stating "What signals: I see no signals!"

I fear that Mr Brown is examining Britain's economy, through a fiscal telescope, placed firmly against his glass eye!

The following is an abstract of an in-depth Economic Analysis the writer has been tracking and preparing for over one year.

I feel that it has interest and a note of caution, to US readers, since the US and UK financial systems tend to suffer knee jerk reactions one to the other. Further, most US banks and investment houses, have major operations in London, thus any large economic corrections in the UK, will inevitably bounce back on the USA.

BALANCE OF PAYMENTS

January's figure, showed that the Current Account (Balance of Trade) soared to a record �4.6 billion deficit.

However, that's not all the story: the Current Account has been in deficit in the region of �4.4 Billion in real (adjusted) terms, now for some months, month on month, varying between �2.6 - � 4 Billion. In October 2003, the deficit was circa 4.8% of GDP, after oil and exceptional items were stripped out.

June 2003 saw the deficit hit �4.5 Billion.

But what does this mean to the economy? Well, any deficit has to be paid for, in hard currency. Normally, a State either borrows to fund a short-term negative position or it sells exchange reserves, to meet the gap. It can, theoretically, discount its own currency, in order to raise settlement funds (normally US $, Yen, Euros etc). The inherent danger in this tactic, however, is to de-stabilise the currency, thereby forcing further endeavours of intervention, which become a sort of self-destructive loop. When Norman Lamont attempted the last major British Foreign Exchange intervention, the result was chaos, collapsed Sterling values and interest rates peaking at 15%.

This factor of the overall economy, however, has to be tied-into other, more worrying realities!

COMPOSITION OF GDP

Presently, GDP (Gross Domestic Product - Britain's "Turnover") is composed of 2/3rds retailing! Since manufacturing is not static, but contracting, the growth in the Balance of Trade Deficit is readily explained.

Thus the "Vibrant" economy, to use Chancellor Brown's terms, is 66% retailing imported goods!

VALUE OF GREAT BRITAIN

Statistics released by the Office for National Statistics, in December 2003, valued Great Britain at �5 Trillion.

However, 55% of this value (�2.7 Trillion), is represented by residential homes! Manufacturing is valued at just � 200 billion: precisely the same value as at 1998! Adjusted for inflation, this clearly illustrates a rapid contraction.

To put the massive over-valuation of residential property into perspective, commercial buildings and public buildings, were collectively worth just � 565 Billion! Almost the same total value as roads, pipelines and railways at � 537 Billion.

The value of residential homes has more than doubled in the past 15 years. From 1999 the average house value was circa �90,000. Today it is put at �175,000. Fairly obviously, neither income nor GDP have expanded at the same or a similar rate.

The most worrying component of this analysis is the single fact that so much of Britain's economic activity and value, is vested, in residential real estate.

Countries create stability of economy, employment and real wealth generation, following the tenets of Adam Smith's economic doctrines. By taking raw material, adding innovation, talent and sweat, one finishes up with something that is hopefully worth more than the original whole.

Globalisation means that a state's economic success, is inextricably linked in synergetic lock-step, with export of value. It is impossible to export houses and blocks of apartments. In the UK, the majority value is the land: this dates right back to the Norman invasion, when William the Conqueror, gave vast tracts of lands to his favourite Barons. Since that time, a majority of the total available land, has been effectively in the ownership of a few. The situation is exacerbated by the failure of government after government to bite the bullet of De-Centralisation, and thus still today, the vast majority of England's population, live in the South East.

With such a predilection for real estate, which consumes the vast majority of available capital, there is little left for engineering, inventing, innovating and manufacturing. When a man or woman, with little or no formal education, but possessed of a sharp mind and an even sharper tongue, can earn �1,000,000 per annum, by wheeling and dealing in what already exists, in the City of London, it is hardly surprising that few young people want to become engineers!

It also explains why we have no silicon industry worth mentioning: and no PC manufacturing: and little primary commercial software design.

Strategically, that's commercial and martial suicide.

BORROWING

By July 2003, debt had risen to circa �1 Trillion: or �16,000 for each man woman and child. Mortgage debt was �713 Billion, �164 on unsecured debts (such as personal loans) and � 50 Billion on credit cards of all types.

More worryingly, Equity Withdrawal (from private residential real estate) increased from � 8.28 Billion in Jan to June 2002: this has increased to � 11.48 between Jan- March 2003 and � 11.29 between April - June 2003.

By September 2003, in and around London the ratio between gross earnings and mortgage debt, had increased to 8.5 (i.e. mortgage obligation was 8.5 times Gross Earning). The normal expected ratio, has traditionally centred around 3.5.

Obviously, the lowest interest rates for nearly 50 years and ever more favourable mortgage terms (including up to 105% LTV - Loan To Value, 28 year term, low-start interest etc) have both fuelled and exacerbated this problem.

Buy-To-Let purchasers have boomed up prices, as people seek to escape from fixed pension traps. As in previous property booms (early 70s; mid 80s) many otherwise sane people, have become "Property Dealers and Investors".

However, Buy-To-Let, has falsely inflated the market, in the South East and increased prices away from First Time Buyers.

There is now a glut of to-rent property and rent-rolls are falling, inexorably.

CONCLUSIONS

Despite the Spin and PR efforts of the Government, the substance of Britain's economy at present comprises residential property activity and retailing. Buyers are spending on home improvements, such as replacing windows, kitchens, bathrooms etc. All create a temporary "Feel Good" factor, economically. The past has shown, however, how quickly this can evaporate, once over-value corrects.

One tangential factor, which has fudged the real issues, is the currency market. Japan has been selling Yen and buying US Treasuries; Mr Greenspan is delighted, as this has assisted him to fund his own internal and external deficits. However, the actions, by the Bank of Japan have been with a purpose. They have falsely kept down the value of the Yen, to assist Japanese manufacturers' recovery. China has been emulating Japan: they have also been falsely valuing their currency, in order to make exports more competitive, racking-up huge trade surplus and investing this in US Treasuries.

The Euro, meantime, has become over-valued, to the detriment of the Eurozone manufacturers and exporters. Expect this to be corrected, by lowered core Euro interest rates, once the European Central Bank gains all its member's agreement to an interventionist strategy, which, as with everything else managed by the lumbering bureaucracy of Strasburg, will take far too much time.

However, all this external activity, will have, finally, an impact upon Great Britain and its currency.

Inevitably, Sterling interest rates will rise: firstly, to cool off an over-heated economy and borrowing: secondly, to protect Sterling's international value, once the US $ recovers, the Yen is freed from its artificial control and China is forced by the USA and G8 to re-value.

Unlike the USA, for example, the Bank of England and thus Government, have only a Single Tier Interest Rate System.

Unfortunately, using primary interest rates as an economic moderator, is rather like using a blunt, but double-sided axe. Increasing Base Rate will of course dampen down the economy: however, simultaneously, it will drastically affect the millions in debt, on unsecured, floating rate obligations, many of whom have created the very economic activity that has allowed the Chancellor to increase his tax take!

Previously, Government worked, in tandem with the Bank of England (B o E), Britain's Central Bank, to modify the economic effects of excessive lending by banks, by invoking "The Corset". The Corset meant that banks and lending institutions, had to increase their effective liquidity ratios, by depositing what are called "Special Deposits", with the B o E, at lower than market rates, thereby increasing the cost of lending, reducing "Hot" flushes of money in the financial system and penalising over-exuberant lenders.

Additionally, Government used various credit restrictions, such as changing the Finance Act, to insist that borrowers made a Front payment, of (e.g.) a minimum 25% for asset finance.

In today's gung ho financial mayhem, it has become Devil Take the Hindmost: sub-prime consumer credit, mainly through unsecured personal loans and credit cards has soared out of all control.

Despite the apparent independence of the B o E, their still exists a tenuous influence by Government. Gordon Brown realises that if the correct level of financial controls were invoked, it would trip a panic, the house market would plummet, the spectre of negative equity would again rise, like the Phoenix from the ashes of the Thatcher inspired economic boom which turned to dust in 1989/90. Personal bankruptcies would once more rocket and perhaps worst of all, consumer spending in the High Street would wither overnight, showing-up the UK economy for what it really is: a series of lose premises based on sublime over-confidence and rhetoric.

Furthermore, one of the present employment dynamics, is the vast consumer-led demand, for so called home improvements. The South East of England is awash with white panel vans, supporting this frenetic and self-destructive lemming-like activity, fitting replacement plastic windows, new up-scale kitchens, bathrooms, bedrooms and floor coverings. Carpet is out: cheap tacky plastic laminate ersatz wood is in! It is nearly all imported. From Mr Brown's perspective, it is all Win-Win, since his tax take from VAT (end use tax), fuel tax, employment tax and so on, have never been higher. It has become a Win-Win scenario, as presently, New Labour have ducked out of the opposite side of the equation, by reducing Social Security Benefits, failing to spend on infrastructure and continuing to implement even more Stealth Taxes.

However, despite huge hikes in the Chancellor's fiscal income, he has had to twice, revise - upwards - his PSBR! (Public Sector Borrowing Requirement). Much of the Treasury's current spend, is on vast consulting projects, aimed at improving and rationalising Government's own administration, or as we call it here, the Civil Service.

Despite incredible spending and record revenues for the major consultancies, little effective improvements have emerged: indeed, some huge fiascos have resulted. Probably the worst examples are the blighted NATS (National Air Control System) computers and more worryingly, the Inland Revenue system. Despite billions already spent and years of integration effort, by such as EDS and Accenture, the systems remain highly flawed.

Additionally, interest rate rises would impact on already hard-pressed industry and most particularly, the SME (Small and Medium Sized Enterprises) whose access to financing is limited, traditionally to major banks and worse, at far less competitive interest rates than Blue Chip corporations. It must be remembered, here, that UK SMEs create circa 50% of GDP and account for circa 47% of ALL private sector employment.

Thus using Base Rate, to endeavour to control the economy, is fiscally incorrect.

Additionally, increasing Base Rates, makes a currency normally rise in the Foreign Exchange markets, thereby putting what is left of British industry under even greater competitive pressure, on export values, when exports are the hugely essential and mainly missing component, essential to start correcting the Balance of Trade deficit.

Base Rate ought more correctly to be employed, with Money Supply, to ensure that Money Supply and GDP are in step: otherwise the result is normally monetary inflation.

An interesting report was published, recently, by the low profile but influential Investment Bank, Durlacher. Last year, David Pannell their Chief Analyst reports, 48% of new mortgage borrowing was where the buyer intended letting the property. First Time Buyers have fallen 37% in the same period. Pannel forecasts that we are headed for a property market collapse. He believes that increased interest rates, tighter lending criteria, more Government intervention in the Mortgage Market, plus a collapse of the Buy-To-Let market will create a crash. He forecasts that prices will drop by between 30-45%.

A number of City firms, including Capital Economics also forecast a sharp price correction. A recent Reuters poll of leading economists indicates that one in five, believe that the property market is due for a sharp correction.

With all the analysis I have completed, I cannot disagree with that conclusion. Further, I am bearish of interest rates and feel strongly that they will rise, as they did in the early 70s and 89/90, since the present level of mortgage and personal debt is unsustainable and will drastically weaken an already highly dysfunctional economy.

The highly prestigious and internationally acclaimed Economist magazine, has published research by its Economics Editor, Pam Woodall, wherein she forecasts that residential house prices are set to "Correct" (i.e. fall) by at least 20% over the next four years.

Woodall, includes the UK (of course!), the USA, Spain, Australia, Ireland and Holland in this analysis.

Apparently, property now accounts for circa 15% of Global GDP.

Swings in housing markets have a far greater downside effect than stock markets, Woodall goes on to say.

The criterion for this fall, is interest rates: these are being held at an all time low, globally, from Japan's effective negative, the USA's effective "0" and Britain's lowest rates for 50 years, despite recent mini-hikes. As these rise, property will nosedive.

Woodall in common with most analysts and forecasters, predicts that the booming British "Buy-to-Let" market, which was worth circa �27 billion in 2003, is set to collapse. Many buyers are finding that rents are failing to service their mortgage obligations as they fall.

Any downturn in the US Economy, is bound to tip the World back into recession, she concludes.

Interesting to me, that Chancellor Brown, has plans to re-introduce the old Development Land Tax, in another guise. This tax was originally introduced by Old Labour, in an attempt to control speculative real estate development and moderate the residential property market. It failed.

Yet on the same day, a report stated that the UK requires a minimum of 120,000 homes per year for Ten Years.

Or overall, 1,200,000, Assuming 2.8 people per dwelling, median, that's an extra 3,360,000 people! Or circa 5% of present population!

Is someone lying again about migration figures?

� Copyright 2004 by AxisofLogic.com

Michael C Feltham FCEA, ACPA, FSPA
Shoeburyness, England

Michael C Feltham is a columnist for Axis of Logic. You can read his work at Feltham on the Economy.  By professional discipline, an accountant, who specialised in international finance and economic analysis in the 1970s. Until December 2001, he was an External Examiner and Moderator to Ashcroft International Business School at their Cambridge and Chelmsford faculties at MBA level. He writes widely on technical finance and economic matters. Michael is Founder and CEO of a software company and CFO of a New Media company.  You can reach Mr. Feltham at: Michaeleff@onetel.net.uk