September 1, 2008 | posted by Michael Baxter in UK economy | comments (0) |

A theme of this newsletter last week was that economists, policy-makers and the markets need to face up to reality. Only then can we get down to the serious business of finding a way out. So it came as a surprise then when, right on queue, Alistair Darling gave his 60-year warning, although as Stephen King pointed out in the Independent, it is difficult to know why Al singled out the year 1948 as the last time things were so bad.

And the critics, with their head still buried in the sand, jumped on the knocking-Darling bandwagon. “Is Alistair Darling turning rabid?” asked one commentator in the Telegraph. “Darling’s job on the line after recession blunder,” said The Times

A raft of reports put it down to political jockeying. TV channels were full of talk from political commentators trying to suggest conflict between Darling and Brown.

Yet the real point behind Darling’s comments was lost on the mainstream TV media. Was he right?

In The Times, Anatole Kaletsky argued our chancellor has just got his sums wrong. He pointed out how much better off we are today than 60 years ago, or even ten years ago, for that matter.

Well, he is right, we are better off, but economic recessions are a relative thing. A recession is defined as two quarters of negative growth – so the contraction would have to be huge for our income to fall lower than levels seen a few years earlier. But that is not the point, crisis is a relative term. Should GDP contract to the heady heights seen, say, ten years ago, then actually, this would be a disaster, and mass unemployment would result.

The truth is, Mr Darling was dead right, and he joins a long list of luminaries who have made similar comments. Both George Soros and Alan Greenspan have talked about the worst crisis since the 1930s, Mervyn King the worst peace time crisis.

At a time when we need to save more than ever before because of the demographic shifts that are occurring, we have been saving less. Now the economy needs us to go out spending to avoid recession, yet in the long-term this is the last thing we should do. This is indeed a very serious crisis.

Solutions exist, some have been expressed here before. Alistair Darling, by admitting to the problem, can at last look at a fix. Well done. For speaking the truth, and seeing reality for it what it is. Now the search for a way out can begin in earnest.

August 29, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Spare a thought for poor old David (Danny) Blanchflower, arch dove at the Bank of England Monetary Policy Committee. “I feel a weight on my shoulders,” he said when talking to Reuters, yesterday. Poor old Danny Boy, he reckons he has failed to convince the rest of his interest rate-setting chums how serious things are and is rather taking it all personally, as if somehow the economic crisis is all his fault.

And while you are in the mood for being sympathetic, spare a thought for Britain’s retailers. They would rather forget the summer just gone, said the CBI yesterday. The employers’ organization released its latest survey on the state of the High Street on Thursday, and boy, it was really awful.

But then again, maybe it is the Office for National Statistics who should be getting our sympathy. It is receiving no end of flak. Recently the ONS reported another set of healthy figures for the High Street. “This can not be,” said our retailers and those who apply common sense to their economic reckoning. The CBI report just gave these critics of the ONS even more ammunition.

Come to think of it, maybe the ONS doesn’t deserve our sympathy after all. Don’t forget, its data has been used by the optimists to help them avoid the vision of reality.

Mr Blanchflower is worried. “I feel that things I have been fearful about have come to pass and I have actually been pretty accurate in what’s coming and I have failed to convince the others of what is appropriate.

“People need to understand that sometimes you will have to focus on the timing of issues. I think people have become complacent and they have not understood what would happen if an economy starts to slow fast, if firms start to close. What we have now is a turning point in many ways – certainly you might think of it as a paradigm shift. We have a global financial crisis, an oil shock coming [and] people with little experience of what is really going on.”

He added: “People have to start to respond to the fact that we are in a recession and the danger is we’ll be in a very serious and long-lasting recession unless we do something. This is a call to action.” And then came the killer punch. You may recall the Bank of England recently predicted GDP will be flat next year. Well, Mr Blanchflower said this prediction has “a great deal of wishful thinking attached to it.”

In other words, Mr Blanchflower is expressing the same sentiments as the article above on the US economy. Until policy-makers see things for what they are, the solution will not be found.

Meanwhile, the latest CBI report on the High Street came out yesterday. The CBI headline index, which is produced by asking retailers whether sales are up or down on the same period a year ago, and taking the percentage balance, fell to minus 46. That is the lowest reading ever recorded by the CBI and its records go back to 1983 – although it did add that changes to the survey mean the 25-year comparison is not entirely accurate.

Andy Clarke, Chairman of the CBI Distributive Trades Panel, and Retail Director of Asda, said: “This has been a summer that many retailers would rather forget. The downturn in the housing market is continuing to depress sales for those shops selling big-ticket items.

“This month’s report also highlights that as disposable incomes tighten, food retailers fare better than the rest of the market.

“Shoppers will continue to be forced to look around for the best value on offer for all their purchases – not just their groceries.”

August 28, 2008 | posted by Michael Baxter in UK economy | comments (0) |

The most damning assessment yet was published on the prospects for the UK economy by the economics consultancy Capital Economics this morning. Their central projection is for the UK economy to contract modestly next year – and recover only very gradually in 2010. But their report also hints at the possibility of a much more serious economic slowdown than that.

It was told here yesterday how many economic forecasts seem to base their projections on data which itself is often flawed. Maybe that is why there has been a total failure to predict the story that has now unfolded. The application of common sense, however, would have yielded much more pertinent conclusions.

Capital Economics seems to take greater account of the more anecdotal type surveys – that’s the type that ask consumers or manufacturers if things are better or worse than a year ago. They also seem a little more willing to use a dollop of thinking, and as a result their projections are often quite different from the forecasts produced by the likes of the IMF or OECD. On the downside, they have been predicting a major fall in house prices for so long, that it could be argued that it was inevitable they would be right eventually. But on the other hand, they did successfully predict a major slowdown in the US economy a year or so in advance, and their predictions for the UK and Eurozone were fairly close to the mark too.

The UK seems to have three types of problem, goes their rather downbeat assessment. Firstly, the various business surveys also seem to paint a picture of growing gloom. Secondly, the economic slowdown in the Eurozone, and growing likelihood that the US will slow again later this year, is making it harder for the UK to export its way out of trouble.

Thirdly is the area of bank lending, and this is the area which the big concern relates to.

Capital Economics argues that unless banks raise more capital, or sell off more assets, they may have to curtail lending by about 7 per cent. This would be a highly significant development. In fact, bank lending has not contracted since 1965. In the US in the early 1930s bank lending fell by more than 50 per cent; in Japan between the late 1990s and early 2000s, bank lending contracted by 30 per cent. So while a 7 per cent contraction in bank lending in the UK will be serious, it won’t apparently be in the same league as the contraction that helped create the US depression and Japan’s lost decade. However, in Finland, between 1990 and 1996 bank lending contracted by 11 per cent, and the result was a 12 per cent drop in real GDP over that period.

If banks do see their asset base contract by 7 per cent, Capital Economics predicts a 1.5 per cent contraction in GDP, meaning the UK slowdown will be as serious as the recession of the early 1990s.

But at last, here is some good news. It is assuming banks will have some success in repairing their balance sheets – and no doubt this is right. They may struggle to raise all the money they require, but it seems likely they will raise more than they have secured to date.

Based on this less pessimistic, but more realistic, assumption, Capital Economics reckons the UK will contract by 0.2 per cent next year, with this contraction sandwiched between 1.2 per cent growth in 2008 and 1 per cent growth in 2010.

It is the most negative forecast published so far, but, frankly, it is probably the most realistic. It will surely be a surprise if the UK does now manage to avoid an outright recession. It seems, instead, the key will be how bad the recession is.

But at least a recession will lead to lower demand for goods and services, which will curtail inflation – and hopefully will make things more affordable in the longer-term. The recovery will surely depend on how soon the improvements in affordability occur.

August 27, 2008 | posted by Michael Baxter in UK economy | comments (0) |

So the UK may have already entered recession. If not, it is at least tottering on the brink. Even the official figures now confirm this.

But where were the forecasters when the seeds to this economic crisis were being sown? Those who based their economic judgement on common sense saw this coming. Those who based their forecasts on data, turned out to have got it completely wrong.

So what lesson can we draw from this?

Last week the Office for National Statistics (ONS) released its latest report on the UK’s retail sector. Bizarrely, it recorded a 3.8 per cent year-on-year rise in retail sales. Yet no one seemed convinced. The British Retail Consortium Director General, Stephen Robertson, said: “Few retailers will recognize this positive picture… we respect the ONS’s process but this report doesn’t seem to reflect the current retail reality.”

At this point you might say: “So what, the ONS data is clearly faulty, why even bother to report it?” But, in a way, that is the point. Data is often faulty. Economic data of this type surely provides no more than a guideline. Equally, one could be dubious of the ONS figures on growth. A month or so ago, it reported that the UK expanded by 0.2 per cent in the second quarter of this year. That was bad. Then last week it re-stated the figures – and this time had the economy flat in the quarter. For the first time in 16 years the UK failed to expand. The longest run of uninterrupted economic growth ever recorded had come to an end. And since records go back to a time when economic growth was much more modest than it is today, the 16-year boom was probably the longest boom ever seen in the UK – that is ever, not since the time of Henry VIII, or even when Julius Caesar first set foot on Britain in 55 BCE, has the UK enjoyed such an extended run of expansion.

But then again, the ONS data has this tendency to be revised, and then revised again, before it is tweaked, and then subjected to revision. Who knows, in ten years’ time the ONS may announce the UK expanded in the quarter just gone after-all, by which time no one will care.

But the trouble is, many economists, including those who advise the government, and who set economic policy, base their decisions on this type of data. And that fact is truly frightening.

Let’s set data aside, and ignore the strict definition of recession, and apply common sense. It is clear the UK , just like the US and most of the Eurozone, is in dire straits. The UK, by any popular definition, is in recession.

And yet, economic forecasters who have based their future projections on data from reputable sources, totally failed to see this coming.

Those who, instead, applied common sense – saw this coming a mile off.

“House prices won’t crash unless there is a recession. And there is no sign of a recession,” we were told. This publication was far from unique in pointing out that this analysis had got cause and effect the wrong way round. A crash in house prices could cause a recession.

“The debt funded economic boom would not carry on until there was recession,” they said, but the reality was that the inevitable bursting of this debt funded boom was always going to create a recession.

So what lesson can we learn? It is this, human nature does not change. It seems innate to our species to exaggerate a trend. That is why we have the economic cycle. This will never change.

The complete failure of respected economic forecasters to see this is a scandal. But it seems that the inability of forecasters to see a bubble for what it is, will also never change.

And how will it all come to an end? When will the recovery begin? Let’s put economic forecasting to one side, and apply some more common sense to answer that question. And for an attempt to answer that, read the next two articles.

August 27, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Recessions are nasty, but is it possible they are also necessary. It is a cliché, but is it not the case that medicine can be very unpleasant.

It seems there are two theories about recession. One idea sees a recession as a wasted opportunity. If the economy has the potential to expand by, say, 2 per cent a year, then if it fails to expand one year, then the economy will always be 2 per cent smaller than it would otherwise have been.

And so recession must be avoided – the cost of recession will last forever.

The truth is, however, that this idea is quite absurd.

During a boom, inefficiencies creep in. Silly ideas get adopted and magnified. Inefficient businesses thrive, some business can thrive even though the fundamental premiss upon which they were based was false.

Only a recession can put an end to these bad practices.

The last few years have seen the emergence of the buy-to-let dream. New landlords found a new easy route to riches. The nation’s would-be entrepreneurs found themselves sucked into a pyramid scheme instead. What a waste of talent.

That most dynamic of work places, the City of London, saw our finest minds, not to mention the finest minds among our immigrant population, taken up shuffling debt amongst one another, creating paper wealth, and engineering an economic miracle built on a pack of cards. What a waste of talent.

It is true that not all businesses that will fail over the next few years will be bad businesses. Some will just be victims of bad luck, and events beyond their control.

But the vacuum that will be created, will provide new opportunity.

The great Austrian economist Joseph Schumpeter calls it creative destruction. That is what we are about to witness.

Yet all this must come with a caveat. The economic turmoil will eventually create a new, more dynamic and sustainable economy, but massive hardship will occur in the interim.

Somehow, policy-makers must try and ensure that the price people pay today for creating longer-term prosperity is not too high. And that is the biggest challenge of all.

August 27, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Jam is not like marmite. Not many of us hate it, then again not many of us love it either. But there is one type of jam that is an exception to this rule in the sense that we all hate it. But this particular variety of jam is not designed for spreading on bread – and does not go with butter. It’s traffic jam – yuk, a most unpleasant accompaniment to any journey.

But here is some good news. Apparently, the amount of traffic congestion on British roads in the first six months of this year was 12 per cent down on the same period last year. It is especially good news when you consider this: maybe the decline in this type of jam provides the first taste of economic recovery.

According to a new report from the Royal Automobile Club Foundation and Trafficmaster, not only is traffic congestion across Britain down, but so too was the average speed on Britain’s motorways. During the first six months of this year our average speed was 62.2 mph, as drivers slowed down in order to try and conserve fuel. (Presumably that is the average speed in open driving; don’t know about you, but the average yours truly manages on the M25 must be nearer 10 mph.)

Georgina Read at Trafficmaster comments: “Our traffic monitoring network shows the start of a change in driving patterns and behaviour over the past six to twelve months. Average motorway speeds have reduced, as has congestion – this indicates a reduction in the volume of vehicles, especially HGVs, travelling on the roads. One obvious explanation for this is that rising fuel prices and general economic concerns are making people think carefully about how they drive. The upshot of less traffic is a drop in congestion levels, meaning motorists can get from A to B quicker while travelling at lower and more economical speeds. It really is a case where less haste can mean more speed.”

The northern sector of the M25 saw the most dramatic decrease in congestion, said the report, with the “sector between junctions 21 and 31, [seeing] a 26 per cent reduction in traffic jams over the 12 month period from June 2007 to June 2008 compared to same period the year before.”

The truth is, the RAC/Trafficmaster report confirms something that has been on the cards for some time. When oil is priced north of $100 it is too expensive for people. It was inevitable demand would fall – and the fall in road congestion is just one example of this happening. The fall in the sales of cars in the US – especially larger cars – is another example of this. And the increase in sales of more fuel efficient Hondas in the US, another example.

This is why the price of oil is bound to fall. And if oil does fall back to $70 by 2010, as has been predicted here, we will all feel a lot better off – and maybe from that base, economic recovery can begin.

Costs rise too high in a boom, this causes recession – which forces prices down too far, which leads to the next boom. The force behind this pattern is the true bread and butter of economic cycles.

August 18, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Every time anyone makes a forecast for the UK economy it seems more gloomy than the previous forecast. But, up to last week, all of the major economic forecasters had stopped shy of predicting recession. Not any longer. This morning saw the gloomiest forecast yet for the UK economy this year and next.

“British business is facing two very difficult years,” began the latest economic report from the British Chambers of Commerce (BCC). It continued: “There is now a distinct possibility of technical recession.”

The BCC report went on to predict that UK unemployment is likely to increase by some 250,000–300,000 over the next two to three years, and that the “golden rule”, which prescribes that the government will only borrow for investment over the economic cycle, is very likely to be breached.

The BCC remedy: Interest rates need to be cut fast. “The longer the MPC waits before cutting rates, the bigger the danger that the situation will deteriorate, and the policy choices will become more difficult and unpleasant,” said the BCC.

It gave a warning, however: “Government temptation to raise business taxes because it is running out of money, must be forcefully resisted.”

David Kern, Economic Adviser to the BCC said: “Over the next two or three quarters, we expect UK GDP growth to be slightly negative or zero. Thereafter, we expect a shallow recovery, but the period of weak, below-trend, growth is likely to be prolonged, lasting until the final months of 2009 or early in 2010.”

“Our view,” he added, “is that the threats to growth are more serious and more immediate than the risks of higher inflation. The UK economy urgently needs an interest rate cut to counter threats of recession.

“Our central scenario envisages that the UK Bank Rate would be cut to 4.75 per cent in quarter four 2008, followed by an additional cut to 4.50 per cent in quarter one 2009.”

It has been said here many times in recent months that, looking forward, deflation rather than inflation may prove to be a bigger challenge for the UK. And cutting interest rates may well be the right thing to do.

However, UK consumers need to reduce their debt exposure. Earlier this year data from the National Institute of Economic and Social Research revealed that the UK had the highest debt to income ratio of the G7. In the US, the wealth to income ratio is 2.52, compared to 2.18 in the UK. The UK’s debt to income ratio is 1.23, compared to 1.16 in the US.

It is important that the UK’s consumers are not encouraged to spend the UK out of economic crisis. Cuts in interest rates at a time of a shortage of credit will be no bad thing – after all, lower interest rates should at least reduce the cost of repaying debt.

But, lower interest rates are not the panacea for all our ills. The UK’ s best prospect for sustainable growth in the longer-term lies with an export-led recovery. And the recent falls in the pound provide the perhaps the single biggest ray of hope for a UK recovery that we have yet seen.

It is funny, though, isn’t it, how these economic forecasts lag so much behind what has been blindingly obvious for so long?

The media has been accused of talking the UK into recession – the reality is that because the media is not a slave to data, it has been able to apply common sense to the economic situation, and common sense has been warning of the very things the BCC is now talking about for months, if not longer.