SUNDAY TELEGRAPH 30.8.09
1. UK will grow sicker until it swallows the bitter pill of economic reality
Millions of ordinary Britons are worried sick about debt and falling incomes. Unemployment and house repossessions are soaring – glib statistics which mask a welter of human misery. Countless UK firms are struggling with cash flow as they try to balance the books. And we're all sick of the grim economic news.
By Liam Halligan
No wonder the UK's "imminent recovery" is getting a lot of coverage. Last week, I returned from holidays abroad to find our media banging the "recession is over" drum. In truth, though, the UK remains in economic dire straits.
I write this not to "talk down the economy" – although I'll be accused of doing so. I'm countering the prevailing consensus because of the evidence. I'm also concerned that by insisting everything is rosy, a vast panoply of political and financial vested interests can claim their counterproductive "rescue measures" are working, while avoiding the tough regulatory changes we need to prevent another "sub-prime".
A series of self-serving surveys has fuelled the "imminent recovery" myth. Based on such hype, and a tidal wave of state largesse, UK shares have surged 15pc over the last two months.
The City was euphoric last week after it emerged that rather than contracting 0.8pc quarter-on-quarter during the second three months of this year, UK GDP fell only 0.7pc. News of this "rebound" was screamed from the roof tops. Less was made of the far more informative year-on-year data showing the economy shrinking by 5.5pc – our worst ever peacetime performance.
Coverage of the actual economic data is being overshadowed by the "results" of heavily promoted surveys from estate agents and stock brokers pointing to "rising house prices" and "growing confidence".
The genuine numbers, alas, show that firms slashed investment by a staggering 10.4pc during the second quarter of this year, more than the 7.6pc cut during the previous three months.
Business capital spending – the lifeblood of growth – is falling at its fastest rate in more than 50 years. Less investment not only suggests more limited future capacity, but lower productivity too – undermining the UK's medium-term growth trajectory.
Combine that with impending tax rises and the reality that we'll be spending ever more of our national income on unproductive debt-service, and it's hard to see how the UK can avoid a prolonged, bath-shaped recession.
The most important piece of data published last week concerned our still deeply dysfunctional credit markets – yet it generated little comment. British banks claim "lending is up" but that's untrue. Billions of pounds of taxpayers' money is being "lent" by banks to their off-balance sheet vehicles – in a desperate attempt to wipe out the sub-prime toxic waste said banks so stupidly took on. But that's not "lending" as far as UK firms and households are concerned.
Net lending to non-financial UK companies fell £4.1bn in July, the steepest decline since the credit crunch began. Despite the bank bail-outs, firms are desperately short of the working capital that makes commerce possible.
Credit-starved businesses will be forced to make more lay-offs in the months to come – particularly the UK's smaller firms, which employ millions of people but are finding it near impossible to access finance. Rising unemployment will push up default rates, not least as interest rates rise, threatening renewed financial turbulence as more mortgage-backed securities go wrong.
The credit crunch has hit the UK hard. Our households are more indebted and our reliance on financial services is greater than any other Western economy. Last week, the International Monetary Fund concluded the UK will suffer a sharper decline in its potential growth rate then the eurozone, the US and Japan as a result of this crisis. I worry, though, that while the UK is already destined to be among the very biggest crunch victims, our so-called leaders continue to foist a policy cocktail upon us that's making our predicament even worse.
Yes – other nations have implemented a fiscal boost. But the UK's finances were in an awful state going into this crisis and we're now borrowing at a faster rate than any other major economy.
Yes – quantitative easing has been used elsewhere. But the UK has been uniquely profligate in spending almost all the newly created "funny money" on government debt, rather than corporate instruments – making us uniquely vulnerable not only to a gilts strike, but also a potentially devastating currency collapse.
"Imminent recovery" is easy to swallow. The bitter pill of reality gets stuck in the throat. The UK needs to swallow hard and face the truth, ending the damaging stopgap measures that put at risk what's left of our economic future.
2. Our quarter-century penance is just starting
Never in modern times has there been such a flat contradiction between the euphoria of markets and the stern warnings of officialdom at central banks and financial watchdogs.
By Ambrose Evans-Pritchard
Corporate credit has seen the steepest rally in almost a hundred years, according to Morgan Stanley. Hedge funds are reviving the final bubble play of early 2007, writing put options on long-dated "volatility" contracts to wring out extra profit.
It is as if the Great Contraction – as the Bank of England now calls it – was just a random shock, as if we should naturally expect "V-shaped" resurgence to take us back to where we were. Yet that is what precisely we are being told will not and cannot happen.
"The current financial crisis is unlike any others," says the Bank for International Settlements. Lasting damage has been done. The "cumulative output loss" is likely to reach 20pc of GDP in the major economies.
The message is the same at the International Monetary Fund. "The world is not in a run of the mill recession. The crisis has left deep scars. In advanced countries, the financial systems are partly dysfunctional," said Olivier Blanchard, the Fund's chief economist.
Mr Blanchard said an IMF study of post-War banking crises led to an unpleasant finding. "Output does not go back to its old trend path, but remains permanently below it."
Then the sting: we are exhausting the limits of fiscal stimulus. "The average ratio of debt to GDP in the G-20 economies was high before the crisis, and is forecast to exceed 100pc in the next few years".
We cannot add debt, so the IMF says we must draw down our future pensions and future health spending to keep today's economy afloat. "A modest cut in the growth rates of entitlements can buy substantial fiscal space for continuing stimulus."
Shouldn't bulls be sobered that the bastion of hard-nosed orthodoxy feels the need to talk in such terms, or that White House officials are preparing the ground for another round of emergency spending even as it reveals that fiscal deficits will reach $9 trillion over the next decade. This is $2 trillion worse than feared in March, and based on rosy growth assumptions.
It has certainly alarmed US retail tycoon Howard Davidowitz. "As a country we are out of control, we're in a death spiral," he said.
All that has happened over this crisis is that huge private losses have been dumped on society: but the losses are still there, smothering the economy. Taxes must rise. Debts must slowly be purged. "As long as economic growth relies on the state, you cannot talk about durable recovery," said European Central Bank member, Yves Mersch.
Nobel Laureate Paul Krugman said the US needs another fiscal blast for "political reasons", alluding to the Great Depression. It was Phase II from late 1931 to early 1933 that tipped half Europe into fascism and brought America soup kitchens. Although such a fate has been averted this time by government action, the Atlanta Fed says the true rate of US unemployment is already 16pc (not 9.4pc), worse than early 1931 levels. Official youth unemployment is 34pc in Spain, 28pc in Latvia, 25pc in Italy, 24pc in Sweden, Hungary, and Greece.
I have some sympathy with the Krugman view, but entirely disagree over methods. The key is to prevent a debt deflation trap – note that producer prices have fallen 8.5pc in Japan, 7.8pc in Germany, and 6.8pc in the US. The least dangerous medication is Quantitative Easing a l'outrance (ie printing money), as the Bank's Mervyn King clearly thinks. This does not add debt. It prevents the real value of existing debt from rising.
Mr Krugman undermined his case by citing Italy as a country that faced public debt of 118pc of GDP in the early 1990s without disaster. Actually, it has caused disaster, even if it has taken this recession to expose the damage. Debt will rocket to 125pc next year (IMF forecasts), and then -- one fears – off the charts.
We know what caused this crisis. The West kept short-term interest rates too low for a quarter century, luring society into debt: and the East held down long-term rates by flooding bond markets as a side-effect of their mercantilist strategy (ie suppressing currencies to gain export share).
The outcome was over-investment, excess capacity, and too much debt among those supposed to buy the goods. Has any of this changed? No. Have we cleared the excess plant? No.
Jeff Wenniger from Harris Private Bank says an army of baby-boomers have seen their old age plans shattered by the housing bust. Their nightmare is here. They will have to spend less, and save more. "Generational destruction of a society's balance sheet down not rectify itself in a matter of months".
How about a quarter century?
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