Tuesday, 23 June 2009
Roger Bootle here lists the green shoots which are significant but then issues stern warnings not to take them too literally. In both this and the World Bank’s warnings and elsewhere I find it hard to see how all these forecasts which totally ignore the effects on national economies of the repayment of QE debt and other borrowings, can be taken seriously.
“Curiouser and Curiouser “ said Alice
Christina Speight
TELEGRAPH
22.6.09
There are still serious structural weaknesses in the UK economy
City scribblers have been falling over themselves to revise up their forecasts. Supposedly, the recession is over. But is it?
By Roger Bootle
There's no denying that green shoots are sprouting – both here and abroad. The clearest evidence that things are improving is the pick-up in the timeliest surveys of economic activity. In the UK, the CIPS/Markit surveys now suggest that the economy is actually growing again. Earlier this month NIESR published an estimate suggesting that GDP rose in both April and May.
In the US and euro-zone, the surveys are still consistent with economic contraction. But they have improved significantly. In the US, the closely watched ISM manufacturing survey reached an eight month high in May. In the euro-zone, the composite euro-zone PMI has now risen for three months in a row.
Meanwhile, in both the US and UK, there are signs that housing market activity is picking up. Financial sentiment has been improving globally too, although stockmarkets have struggled to make further progress in the past few weeks. Even the traditionally more lagging labour market data are showing some signs of improvement. In May, the number of people claiming unemployment benefit here posted its smallest monthly rise since last July. In the US, May's drop in employment was the smallest in almost a year.
Three major factors are driving the improvement. First, there is a recovery in confidence, reflecting relief that the Armageddon scenario of a complete collapse in the banking system and the wider economy has been avoided. The Government appears to have shored up banks' capital positions adequately, at least for now, so worries about a repeat of the Great Depression have receded significantly.
Second, the stock cycle has turned. The run-down of inventories exacerbated the falls in output. But now the worst of that de-stocking appears to be over. Similarly, the collapse in world trade went well beyond what could be explained by the weakness in demand, due in part to a shortage of trade finance. Accordingly, there is plenty of scope for a bounce-back in world trade, even without much of an improvement in underlying demand.
Third, the economy is benefiting from a whopping amount of support from both monetary and fiscal policy. Interest rates are at record lows around the world. A number of countries, including the US and UK, have turned to measures to boost directly the quantity of money in the system – quantitative easing. And fiscal policy has been loosened worldwide.
Given all this I would be extremely worried if the economy was not now showing some signs of life. But that doesn't justify an outbreak of optimism. You'll remember that virtually no economic forecaster saw this whole mess coming. Just as they got it wrong as the economy was on its way down, so they are liable to get it wrong as the economy seems to be picking up.
What most forecasters are doing is what they usually do – looking at the most recent trends and extrapolating them. But I don't think this is the right way to think about matters. I think you have to look at the fundamental factors driving the economy and, on the basis of past experience, follow what they suggest might happen.
There are still some serious structural weaknesses in the global economy and these cause me to think that any recovery will be weak. My prime concern remains the banking system.
Collapse may have been averted but the supply of bank credit remains constrained. Even though governments have pumped large amounts of money into the banks to repair the damage done by write-downs of toxic assets, banks have yet to face a further wave of write-downs related to plain old lending. The ECB last week estimated that euro-zone banks have so far incurred, at best, just half of their potential losses. And the IMF has estimated that Britain's banks have written off only a third of the losses they will ultimately face.
As Mervyn King said in his speech to the Mansion House last week, "stress tests designed to assess the viability of banks are very different from tests of the capacity of the banking system to finance a recovery."
Moreover, households' balance sheets are still in a pretty poor state – suggesting that they will be "deleveraging" for years to come. Household saving rates have risen globally, and particularly in the US, but they still look low by historical standards. They also look low relative to households' net wealth, following the falls in house and share prices over the past couple of years. And in many major economies, households will probably suffer from further falls in house prices and further rises in unemployment.
Meanwhile, the risk of deflation is still very much alive and well. In the UK, pay freezes or even outright cuts in pay are becoming commonplace. If this continues, and firms start to see labour costs, if not fall, at least rise more slowly than productivity, then inflation could drop sharply, even into negative territory.
While all these factors are still working away to restrain the recovery, the thrust of policy is about to change.
Here in the UK, another set of dreadful public finance figures last week left public borrowing on track to total close to £200bn this year.
Governments have done the right thing to let borrowing rise in order to support the global economy as it fell into recession. But they will soon have to get borrowing down again, by spending cuts and or tax rises.
There is also a danger that a misplaced concern about the risks of inflation, rather than deflation, prompts central banks to tighten policy by raising interest rates and/or reversing quantitative easing too quickly, thus snuffing out the recovery before it has really even got going.
After normal recessions, early signs of an improvement have quickly turned into a sharp acceleration in growth.
But this hasn't been a normal recession. So it would be foolish to assume that it will be a normal recovery. This recession has been induced by a banking crisis and financial collapse.
Previous examples of this phenomenon have included Scandinavia and Japan in the 1990s, and America in the 1930s. In each of these cases it has taken several years for bank lending to pick up and the overall economy to recover.
The real issue now is not about when the economy first shows signs of picking up but rather, when it comes, how strong and sustainable the recovery will be.
On that I reckon that there are good reasons to be cautious. I expect a prolonged period of sluggish economic growth at best. At worst, I wouldn't be surprised if the recovery stalled. If the economy does pick up strongly from here you can berate me for my persistent pessimism.
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Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.
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