The last few weeks have seen a collective bout of economic delusion and I am mightily relieved to find that the sensible economic commentators were merely on holiday and hadn’t given up in despair. In 24 hours we’ve had Ambrose Evans-Pritchard, Liam Halligan and Ruth Lea all warning of a tough future.
The US picture is one of gloom too as “ as the White House projected the budget deficit would be $2,000bn higher over the next 10 years than it had predicted. Taken with a separate forecast by the independent Congressional Budget Office, the news presented a bleak picture of America’s deteriorating debt position.
The CBO released sharply higher deficit projections predicting the 10-year deficit would reach $7,140bn, some $2,700bn more than it had thought in March. Unlike the White House’s calculations, the CBO estimate assumes all policies will stay exactly as they are. . . . The deficit projections are a political millstone for the Obama administration as it seeks to promote health reform and other priorities” (FT 26/8/09)
Yes - It will be tough all round!
Christina
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THE TIMES
26.8.09
Summer recovery will turn to a cold winter
The markets are rallying and confidence is returning, but don’t be fooled: there can be only hard economic times ahead
Ruth Lea
Market sentiment has in the past few months gone from bearish to bullish as pundits have declared the end of recession. The mood has gone from deep despair to extraordinary elation — this week marked the biggest six-month rally in world share prices for 50 years — as good news takes centre stage and bad news is consigned to the wings.
For example, last week’s comments by the Chairman of the Federal Reserve were interpreted with such partiality. Ben Bernanke’s statement that the US was “beginning to emerge” from deep global recession, allied with some better news from the US housing market, was more than enough for the markets to push ahead. His measured tones about “challenges to growth” and his view that the recovery would “be relatively slow at first, with unemployment declining only gradually from high levels” were pushed aside.
In the dog days of summer, when boredom can be the biggest challenge to players in the markets, Mr Bernanke’s modestly upbeat remarks were enthusiastically received. Traders are human, after all, and want to find an excuse to trade. [an important factor. The markets live by trading itself and only partly by rising share prices. -cs]
Meanwhile, in Britain business surveys are being dissected and their entrails examined for signs of recovery. One such survey by the Institute of Chartered Accountants was released on Monday and, on showing a remarkable bounce in business confidence, was interpreted as another sign of the “end of recession”. Moreover, it forecast that third-quarter GDP would rise by 0.5 per cent. Recovery, indeed.
But business surveys have two intrinsic shortcomings. The first is that they are subjective — they are just opinion polls after all — and difficult to standardise over time.
The second is that they do not give direct and quantifiable estimates of changes in the economy. So even though they can be useful indicators of mood, they should come with a health warning. On the basis of such surveys and other snippets, the respected National Institute of Economic and Social Research projected a decrease of about 0.4 per cent for second-quarter GDP. The Office for National Statistics then shocked punters with a preliminary estimate of a 0.8 per cent fall.
But market sentiment and surveys aside, how is the economy likely to fare, and what will consumers face over the next six to twelve months? Apologies for being Cassandra, but I do not see comfortable times ahead.
The biggest problem that the country faces is the disastrous nature of the public finances. The latest public sector borrowing data was shockingly bad — the public sector chalked up a record July deficit of £8 billion as tax receipts slumped. In the April Budget, the Chancellor forecast total borrowing of £175 billion for 2009-10 but, given the new data, it could be nearer £200 billion. Britain’s public sector finances are the worst of any of the leading economies and over the next few years there will have to be a significant fiscal consolidation. This will mean higher taxes or public spending constraints or, most likely, both. Inevitably, individual consumers will bear the brunt of any tax rises, which will significantly hit their pockets.
Tax rises are already pencilled in. On September 1, the day that frosted light bulbs will disappear from the shelves to save the planet, fuel duty will rise by 2p a litre (2.3p including VAT). The stamp duty holiday on properties costing under £175,000 will finish by the end of the year and the standard VAT rate will return to 17.5 per cent in January 2010. A new 50 per cent income tax band comes into force in April next year.
But these tax increases are likely to be just the tip of the iceberg. The eventual degree of fiscal tightening over the next few years is hotly debated, but to stabilise public finances, reductions in borrowing of about £70-80 billion seem reasonable, if not modest. Four percentage points on the basic income tax rate, from 20 to 24 per cent, could raise £20 billion. An increase in the standard rate of VAT from 17.5 to 20 per cent could yield almost £12 billion. Well, that’s £32 billion maximum — still less than half the reduction in borrowing that is probably required. These figures illustrate the size of the challenge facing the next Government.
There are some brave folk who suggest that Britain will experience a sharp V-shaped recovery and the economy will grow buoyantly next year. But this is not credible. This recession is unique in terms of its combination of difficulties. In addition to the prospect of sharp tax increases and/or tough public spending constraints, the continuing impairment of the banking system and the restrictions on bank lending will, at the very minimum, act as a drag on recovery.
It is hard to see where the drivers for buoyant growth will come from. Personal consumption will be inevitably constrained by the tax rises in the pipeline. In addition, unemployment will continue to rise well into next year, if not into 2011, which will depress aggregate household incomes. And households will still be working off the effects of the great pre-2008 credit binge by drawing back on spending and reducing debt.
The second component that drives growth is exports. But I do not expect Britain’s main export markets — the US and the EU — to bounce back into rude good health, despite signs that the worst may be over in those countries. [The Libyan dêbacle won ‘t contribute to exports to the USA one little bit -cs]
A third component is business investment in capital goods, but businesses tend to invest in response to growth rather than to lead it. [They’ll also need to borrow to do this. Who’s lending? -cs]
Finally there is public spending, which has surged since the turn of the millennium but, as already indicated, years of feast will have to turn into years of famine.
In recent years both the public and private sectors have been addicted to the accumulation of debt. It is now payback time and the economy will be in “cold turkey”. Expect belt-tightening all round and a rocky road ahead.
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Ruth Lea is economic adviser to the Arbuthnot Banking Group
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