Britain is Sleepwalking towards a Decade of Economic Misery
by Liam Halligan
Posted originally in The Daily Telegraph
25 Aug 2009
THE RECESSION IS OVER. The stock market is powering ahead, business confidence is rising and – joy of joys – house prices are looking up. Sit back, relax and bask in the late summer sunshine. The UK is about to enjoy a spectacular V-shaped recovery.
Worried about your debts? Fear not, we’ll have ultra-low interest rates for years to come. The world’s leading central bankers just said so. No need to save, then – we Brits can borrow and spend our way out of trouble. Again.
I’m not, by nature, pessimistic. I’d really like to say the economy is out of the woods. If I could see signs of genuine growth, I’d shout about them from the rooftops. But I can’t honestly say I do. Instead, I see lots of stockbrokers, estate agents and other vested interests talking up “imminent recovery” with no reference to fundamental economic realities.
While desperately wanting to believe the “green shoots” brigade, ordinary households are struggling to remortgage and otherwise viable firms still can’t access working capital. Amid the City’s summer euphoria, the wider economy continues to haemorrhage jobs – with all the associated fiscal fall-out, to say nothing of the human misery.
Having enjoyed a six-day rally, UK shares have just hit their highest level since Lehman Brothers’ collapse last September. This latest price surge is the centrepiece of claims we’ll soon return to the sunlit economic uplands.
Yet this stock market upswing is based on little more than hype. Shares have risen in part due to firms imposing one-off cost savings – such as cutting their head count – but mainly because of unprecedented Government intervention.
Any beneficial impact of our wildly expansionary fiscal and monetary stance will soon be over. Once the sugar rush fades, and global investors are back from their summer break, asset prices will start reflecting the far more significant downsides of the UK’s reckless policy of printing money and racking up ever more Government debt.
Whatever the “news” from the latest self-serving business surveys, output shrank by a shocking 0.8 per cent between April and June. All parts of the economy remain in recession, apart from the public sector. After five successive quarters of contraction, UK output is down almost 6 per cent since the spring of 2008 – more than double the depth of the early-1990s recession.
Once an economy has nose-dived for more than a year, the annual pace of decline obviously slows. But our so-called leaders now point to this arithmetical inevitability as “evidence” that their counter-productive policies are working. “Imminent recovery” is being used as an excuse to put off the tough fiscal and regulatory measures we need to rebalance our finances and avoid a repeat of the sub-prime fiasco.
Banks continue to hold the rest of the country to ransom, refusing to extend credit on reasonable terms, despite replenishing their balance sheets off the back of taxpayer largesse. They remain unwilling to lend normally, even to each other. That gums up the wheels of finance, starving credit-worthy firms and households of badly needed cash. This inter-bank torpor stems from fear of counter-party risk, with banks still sitting on billions of pounds of toxic liabilities which they refuse to reveal.
A braver government, a wiser government, would have forced the banks to fess up to these losses before splashing the bail-out cash, so purging the system and allowing a genuinely restructured banking sector to dust itself down and start again.
Such “creative destruction” isn’t pretty, but it’s what makes capitalism work. The grim truth is that meaningful economic recovery will elude Britain as long as we remain burdened by our newly created, Japanese-style “zombie banks”.
This is the heart of the problem – yet politicians don’t want to know, so scared are they of annoying the banking deities and jeopardising future political donations. Our banks are feasting on a diet of taxpayer cash, while charging usurious rates on extremely limited lending books. Britain, meanwhile, sleepwalks towards a lost decade.
Claims that we’re in for a rapid recovery rest on two myths. The first is that we can “spend our way out of recession” and fix the public finances later. As the economy has stagnated, the national accounts have bled ever more red ink. In July, usually a surplus month as tax revenues roll in, we saw a record-breaking £8 billion deficit. Corporate tax receipts were down a staggering 38 per cent on the same month last year.
In any downturn, the public finances suffer as tax and spending pull in opposite directions. But the bank rescues and ongoing Government profligacy are tearing our balance sheet apart. We’re now issuing more government debt as a percentage of GDP than any other major economy. The UK is on course to borrow more than £200 billion this year, twice as much as France and Germany. Since March, the Bank of England has spent £130 billion of funny money created by quantitative easing (QE), the vast majority of it buying back gilts from the market. That’s our dirty secret: without the prop of QE, we’d already have seen repeated gilt auction failures, with the UK unable to roll over its debts.
Despite the talk of recovery, sterling just hit a three-month low. It can’t be long before the currency markets rebel – something that can’t be covered up by QE.
The second myth is that we face impending “deflation” – which is used to argue not only that QE is justified, but also that the Bank of England will be able to keep interest rates low for years to come.
Where is this deflation? The credit crunch has been in full swing since the summer of 2007. Yet only in the past two months has Consumer Price Index (CPI) inflation even fallen below the Bank’s 2 per cent target, let alone risked going negative.
That’s despite the fact that CPI grossly understates inflation anyway. And had VAT not been cut last December, even the CPI would still be above 3 per cent – with the Bank writing public letters explaining why it’s so high.
Oil prices just hit $75 a barrel, their highest level this year. Given that crude plunged below $40 last autumn, continued high oil prices will add mightily to inflation in the coming months. And that’s on top of unprecedented monetary expansion. Higher inflation will make it even harder to sell the hundreds of billions of pounds of gilts set to be issued over the next 18 to 24 months. Higher inflation will also make it impossible for the Bank to keep rates low.
Meanwhile, our decade-long borrowing binge means that, for years to come, the UK will fritter away a huge chunk of our national income in debt-service, rather than productive investment.
I want the UK to recover as much as any Telegraph reader. But unless we face reality, and end the stop-gap measures that are making our predicament even worse, genuine recovery will be pushed further into the future. So enjoy the economic summer sunshine while it lasts. It could well be the lull before yet another storm.
Liam Halligan is chief economist at Prosperity Capital Management.