The new U.K. Chancellor of the Exchequer, Philip Hammond, is in New York today trying to woo investors by assuring them London remains open for business. So let's take a look at the British government's plans after the Brexit vote.
A day after U.K. Prime Minister Theresa May delivered a speech that many said broke tradition with the Conservative Party's pro-business stance, the Financial Times wrote, quoting a source close to May, that the government plans to increase spending on infrastructure.
This is hardly news. Fund managers in London were expecting such an announcement and positioning accordingly. In a chat with journalists last month, Neil Hermon and Indriatti van Hien, fund managers at Henderson Global, said infrastructure would be a priority for government spending.
Former Chancellor of the Exchequer George Osborne warned before the June 23 referendum on European Union membership that if Britain voted to leave, an austerity budget would need to be introduced to deal with the loss of credibility.
He resigned shortly after Theresa May's appointment as Prime Minister, and Hammond canceled Osborne's plan to bring the budget to surplus by 2020. Businesses and investors welcomed the U-turn, saying the country needs investment in order to boost economic growth.
While that is true, it is no less true that the U.K.'s budget deficit is higher than that of any other developed country at this point.
The last time the U.K. budget had a surplus rather than a deficit was in the year 2000. Currently, the budget deficit is at 6%. Such a level is more consistent with that of a fast-growing but imbalanced emerging market, rather than that of a mature Western economy.
The gap is caused by big spending on welfare. For example, the housing benefit bill -- in essence the government covering housing costs for people who make too little money to pay market rents -- makes up more than half the budget deficit.
So not only does the U.K. have a big budget deficit, its cause is spending on consumption, rather than spending on investment. That is never a good sign. Who is to say the new borrowing the government will take on won't go in the same direction?
It is always easier to implement populist measures by giving state handouts to voters than to invest, as investing is a longer-term policy. And if there is anything we've learned from Theresa May's speech yesterday, it is that her government will not shy away from populist measures.
Another deficit that investors should worry about is the current account deficit. Take a look:
The chart above shows that the last time Britain's sales abroad equaled its imports was almost two decades ago. Indeed, Bank of England Governor Mark Carney warned before the Brexit vote that Britain has been "relying on the kindness of strangers" for too long.
The 6% current account deficit is beginning to be corrected by the fall in the pound's exchange rate vs. other major currencies. But for investors in government bonds, that is cold comfort: Why would you want to hold an asset that is denominated in a currency that looks almost sure to keep weakening?
One reason for investors to buy U.K. government bonds stands out: They still have a positive yield. The crucial question that investors must answer, though, is this. Does a 0.7% return on a 10-year U.K. government bond justify the risk of seeing your investment eroded by inflation and a falling currency?
Philip Hammond will try to persuade you that it is. Listen to what he has to say, but make your own decision.
Editor's Note: This article was originally published on Real Money at 8 a.m. on Oct. 6.