Cast your mind back to a year ago. Back then many were warning of tough times ahead for the US. Alan Greenspan said there was a one-in-three chance of a recession, while predictions of doom for the US housing market – which, by the way, were mostly ridiculed, were growing.
And yet for much of last year the US continued to confound the sceptics. US consumer confidence soared last July, hitting the highest level seen for a very long time, US manufacturing continued to defy predictions of doom, the likes of the IMF and OECD continued to predict reasonable economic growth for the US in 2008, and many US businesses asked what all the fuss was about.
It was clear the US banks were in for a downturn, but many concluded that the banks had become so preoccupied with their own problems, that they had become blinded to reality. Projections for company results remained on the high side, and the Dow seemed to pass new all-time highs with tedious regularity.
We claim no award for prescience in warning things were set to turn, we were far from alone – but many in the US, especially on Wall Street, seemed to bury their head in the sand, and totally failed to see what was coming.
It now seems clear the US is in recession – and the big debate is now over how serious it will be. All those optimists of last year who asked, Crisis, what crisis, really do have egg on their face now.
So, will the UK follow the US?
In the UK, some sectors of the economy are still performing well, services are keeping their heads up nicely, with the latest report from the Charted Institute of Purchasing and Supply indicating that the sector is expanding at a good rate of knots. Yesterday, the CBI released its latest industrial trends survey – again its reading is on the high side.
Anecdotal evidence from many businesses suggests that many CEOs are somewhat incredulous about all this negative talk – with some saying we are in danger of talking ourselves into recession.
Actually, all this evidence to suggest the UK is still strong is not at all dissimilar from the positive evidence from the US last year, so maybe we shouldn’t attach too much weight to these positive surveys.
It seems that in the UK, the real danger, just like in the US last year, lies with the consumer.
Maybe the announcement yesterday from Next that like for like sales were down by 3.3 per cent, is a sign of things to come.
Capital Economics has been doing some sums, and they don’t make pretty reading.
Household debt, relative to income, has risen by 48 per cent over the past ten years in the US and by 71 per cent in the UK, it says. But, perhaps more tellingly, total household debt now stands at the equivalent of 175 per cent of household disposable income in the UK, compared to only 138 per cent in the US.
On the flip side, the UK net worth as a percentage of income is higher in the UK than the US, suggesting perhaps we can afford far more debt.
This is a slightly misleading measure. After all, our net wealth is a function of the value of property, and if house prices fall in the UK, as they have been doing in the US, the ratio of wealth to income will plummet.
And therein lies the real danger for the UK. According to the Nationwide, house prices in the UK have risen by 198 per cent since 1997, while the Case-Schiller index measured a mere 116 per cent rise over that time for the US.
Capital Economics has also found that in the UK there is a very strong correlation between consumer spending and property inflation.
But the real worry must surely relate to this point. Just like the US, our savings ratio is very low. It’s difficult to compare the UK and US savings ratios as they are calculated differently, with the US taking into account depreciation on capital assets – wear and tear on property, for example. After taking into account depreciation, Capital Economics has calculated that the household net savings ratio in the UK is even lower than in the US – only marginally above zero.
And surely it’s that piece of data that is the killer.
Some say our low savings ratio doesn’t matter because it is made up for by rising wealth via increasing house prices – well we are sure we don’t need to spell out the errors to that argument.
It seems the UK consumer is just as indebted as a percentage of income as the US consumer. Furthermore, since the rate of interest is higher in the UK, one assumes the cost of repaying debt is higher for British consumers.
Capital Economics said, “There has recently been a lot speculation about whether the rest of the world, including the UK, has “de-coupled” from the US. But the issue of whether or not the direct links between the US and UK economy have weakened side-steps the issue of whether the factors which caused the US slowdown are also present in the UK. We think that the imbalances in the US consumer sector are just as – if not more – prevalent in the UK. Accordingly, the UK looks set to follow the US into a consumer-led slowdown this year – with a not insignificant chance that both economies fall into outright recession.”
That may all seem pretty damning, but there is worse to follow.
Last year, we reported on a study from the US Economic Policy Institute that found US production has jumped 20 per cent since 2000, but over that same period, the real median hourly wage of all workers jumped by just 3 per cent. In fact, it found that since 2003, the median hourly wage has actually fallen Stateside, down 1.1 per cent, while production soared 5 per cent.
The survey seemed to point out a fact many seemed to overlook. Sure, the US economy has been booming, but many workers have been getting worse off. So not only has debt been rising in the US, consumers’ ability to repay debt has been worsening. This is in sharp contrast with previous economic periods, when high inflation meant the true value of debt was being eroded fast.
It is the same in the UK. We have reported on many occasions, how our disposable income, after paying for goods and services we simply have to pay for, ie cost of travelling to work, mortgages, or rent, council tax and utility bills, has been falling.
So just like the US, while our debt has been rising, our discretionary disposable income has been falling.
Just like the US, then, the underlying problem in the UK is too much debt and not enough saving.
The only way the UK can see a much-needed readjustment in savings and borrowing, without a recession occurring, would be if exports took up the slack.
The recent fall in the pound, though, does provide us with hope. As was said in the article above, there is evidence that less money is flowing into the UK. We blame the credit crunch on banks not trusting each other, but presumably this slowdown in the flow of money from abroad must be a factor too.
But, at the same time, this is leading to falls in sterling, and in the process creating the foundations of an export-led recovery.
Will this be in time to avert recession? Probably not, but at least it tells us where our hope for recovery could come from.
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