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.

August 14, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Sometimes central bankers talk in code. Words like continue, contained and moderate, seem to come loaded with enough hints and insinuation to keep the media talking for weeks. Alan Greenspan used to go to the extreme, and was downright cryptic. In fact, he once famously said: “If I seem unduly clear to you, you must have misunderstood what I said.” But yesterday it wasn’t like that. Mervyn King, governor of the Bank of England set the tone with his opening sentence in yesterday’s inflation report published by the Bank.

“It may still – just – be summer,” he said, “but there is a feeling of chill in the economic air.”

Okay, there was one word Mr King, in his moment of candour, just wouldn’t use. He just could not bring himself to utter the R word. But, he made it quite clear this nine-letter word, that policy makers dread so much, was on his mind.

When the Bank of England makes its projections it presents a range of possible outcomes, attaching probability to each outcome, and it presents this information as a fan chart. The fan chart deviates around a central projection. And the central projection is this: economic growth will slow to around zero by the end of this year. For the next year or so, the Bank expects growth to be “broadly flat.”

In other words, the Bank of England is now saying the economy is just a whisker away from recession – if it has overestimated growth by the tiniest amount, then it’s recession.

Bear in mind, projections for growth have been steadily falling. When the Bank published its previous inflationary report, three months ago, it was expecting growth to bottom out at around 1 per cent. Three months ago a single quarter of negative growth did show up on its fan graph, but only just, and a very slim level of probability was attached to this outcome. Now it is suggesting there is a possibility of a recession lasting over a year.

But while the Bank of E gave its strongest warning yet on the dangers of recession, it was altogether more sanguine on the inflation front.

Sure, it expects inflation to rise some more. Its fan chart even allowed for the possibility of inflation hitting 6 per cent.

Furthermore, it expects inflationary pressures to mount for another year or so, but, then, it thinks things will go into sharp reversal. It expects inflation to be lower than 2 per cent within two years.

All in all, then, what with the grim warnings on growth, and the more positive attitude to inflation, analysts have reviewed their predictions on the future course of interest rates. Now, the expectation is for rates to fall later this year. Until yesterday, most had expected one more hike in rates.

The trouble though with these Bank of England reports, as indeed with just about all forecasts, is that they tend to be behind the curve. They base their projections on data, but the data is flawed. Instinct, even common sense, does not come into it.

Sure, the Bank of England, just like every other forecaster, has downgraded its projections – but they are only really being downgraded to what we all suspected all along.

Some have accused the media of talking us into a recession. This is not true. The media are not hamstrung by flawed data, and for that reason their warnings have, quite frankly, had more credibility than the gentle and periodic downgrades we have been seeing from those who are supposed to be in the know.

In its latest fan chart, the Bank of England made no allowances for the possibility of negative inflation over the next couple of years.

But, consider this. Latest data on the job front, also out yesterday, revealed that wages rose by just 3.4 per cent during the April–June quarter of last year. That was with bonuses; without bonuses, average earnings were up 3.7 per cent.

The fact is, while inflation has been rising, average earnings have been falling; they have only been falling slightly, it is true – but it is surely highly significant that they are going in the opposite direction to inflation.

As for unemployment, this rose by 0.2 percentage points, or by 60,000. However, the number of people in employment did rise by 20,000. But the growth in employment seems to be coming to a standstill. Expect this to go into reverse soon.

As we have argued here many times, this time around there are good reasons to believe fears on job security could lead to much more modest wage rises in the year ahead.

It seems more likely the Bank of England has understated growth and inflation in the short-term, and overstated inflation in the medium-term.

Projected growth Bank of England inflation report: August

Projected growth Bank of England inflation report: May

August 8, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Prepare to groan – bad joke coming up. The IMF used to have trouble making up its mind; now it is just not sure.

Three weeks ago, this influential and much respected financial institution, upgraded its projections for economic growth for the UK. Well, that was July. Clearly, things must look very different in August, because now it has changed its projections again, this time, downgrading them, and by quite a bit too.

It now expects the UK to grow by 1.4 per cent this year. This contrasts with its previous projection of 1.8 per cent, and the projection before that of 1.6 per cent. So far this year the UK has expanded by 0.4 per cent in Q1, and 0.2 per cent in Q2, so if the IMF is right, the second half of the year will be slightly worse than the first half.

As for 2009, it now expects growth of 1.1 per cent. This compares with its previous projection of 1.7 per cent, and prior to that it projected 1.6 per cent.

All in all, then, the latest IMF forecasts are by far the worst to date. In fact, actually, a growth of 1.1 per cent for 2009 is barely above recession pace. Remember, a recession is defined as two successive quarters of negative growth – which could easily be contained within a 1.1 per cent annual growth rate.

Also of interest from the latest IMF report, it turned its attention on inflation and the fiscal deficit.

It said: “Inflation rose to 3.8 per cent in June, on account of food and fuel price developments. And while there is scant evidence of second-round effects, as wages remain subdued, indicators of long-run inflation expectations have risen further.”

On the fiscal deficit it said it recommended: “… that the net public debt ceiling of 40 per cent of GDP be retained. Should it be breached,” the IMF said, “concrete and frontloaded plans” should be introduced “to bring debt back below the ceiling.”

Its comments about inflation seem to be about right. There are good reasons to expect inflation to fall, but, unfortunately, the UK public don’t seem to agree; they expect inflation to stay up. How serious this is depends on your point of view. If you believe inflation is determined by expectations, then the high level of expectations in the UK is worrying. On the other hand, economic theory often seems to assume we are a lot cleverer than we really are. Quite frankly, most of us tend to assume the next few quarters will be like the ones just past. So, inflation rose yesterday, and is still up today; we assume it will be high tomorrow.

And in a way, that aspect of human nature says a lot about why we have economic cycles. Most people refused to believe house prices could ever crash, because they assumed the economic conditions would not change. They said: “Look at how low interest rates are, and how plentiful credit is.” They did not factor in the fact that both these variables could change. That is just one example; go back through economic history and you will see this aspect of human nature behind many of the booms and busts.

It often seems economic theory is quite flawed in the way it assumes some kind of all-knowing aspect to human nature.

The reality is that since our expectations are determined by the recent past, our expectations for inflation will always be behind the curve. Actually, if you look beneath the surface, there are good reasons for thinking inflation will reduce quite sharply, and may even go negative towards the end of next year. It seems unlikely many of us have factored the deep forces at work when we are asked our expectations.

As for the IMF’s comments on public debt – it is worth noting the IMF has a thing about low public debt. It always wants countries to cut this. In 1997, it practically forced reductions in debt in the economies of East Asia – and in 1998 it did the same with Russia. In both cases, the result was a very nasty and avoidable recession.

The UK can not possibly keep net debt below 40 per cent of GDP; to attempt to do that right now would be tantamount to forcing a recession. As we have argued before, the government should in fact allow its net debt to rise, and spend some of the proceeds on tax cuts, especially aimed at the lower end of the income scale, and in the process increase incentives to work over claiming benefit.

August 6, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Well, we are dipping into our savings. According to Abbey, average ISA savers have withdrawn £579 each (£6 billion in total), which equates to 26 per cent of the average ISA subscription for 2007/2008.

Almost a third (31 per cent) of those questioned said that it was day-to-day costs which had forced them to make withdrawals while a further 15 per cent specifically cited bills such as mortgage repayments or utility bills as the reason for pulling out their cash.

For a significant number of us it was our spending urges that prompted us to head for our savings. A quarter (26 per cent) said that their ISA money had gone towards a luxury item such as a holiday or car purchase while a further eight per cent said that it was a High Street shopping trip which had parted them from their cash.

Thirteen per cent of those questioned had put their money towards helping friends and family with their finances while almost a quarter (24 per cent) said that their savings had to be called upon for an unanticipated cost such as an emergency home repair.

Reza Attar-Zadeh, Director of Savings and Investments at Abbey: “With the cost of living increasing, a significant number of us are being forced to use our savings to meet the rising costs. You never know when you’re going to need to fall back on your savings and in this respect dipping into them to meet bills such as gas bills is no bad thing.”

You can understand why we are dipping into our ISAs. The worry though is that we are supposed to be saving more. Remember the pension time bomb. Remember, also, we are collectively in too much debt. So, right now, the UK savings ratio should be rising.

Abbey warned: “Dipping in to your ISA savings could prove costly in the long term. With a Cash ISA allowance of £3,600 per tax year any withdrawals made can not be replaced, so that part of your allowance would be lost forever. If you’re saving towards a goal such as home deposit or looking to maximise the amount of cash you have put away for retirement then the advice must be to try and reduce your outgoings rather than dip into your ISA pot.”

The snag, though, is that while we all need to save on an individual basis, this is the last thing the economy needs. It is what Keynes called the paradox of thrift.

And this is the real problem haunting the UK. We somehow need to save more, and repay debt, but without sending the economy into a downward spiral.

August 4, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Here is something else that is strange, and this time it’s good news. According to the government’s Insolvency Service, there was a fall in the number of new personal insolvencies in the second quarter of this year.

According to the government’s Insolvency Service, 24,553 people became bankrupt or entered into an Individual Voluntary Arrangement (IVA) in England and Wales between April and June of this year. This represents a 2 per cent decrease on the previous quarter, and a decrease of 8.3 per cent on the same period a year ago.

Now, this is strange, when you consider there is this thing called a credit crunch in full swing at the moment.

But then again, the figures from the latest quarter suggest they are on course for over 100,000 insolvencies for this year, and by historical standards this is high. In the early 1990s, for example, insolvencies peaked at 36,000.

Charles Turner, personal insolvency expert at PricewaterhouseCoopers LLP, said:

“People may be surprised that the personal insolvency numbers have fallen a little this quarter, but we believe this is because the ‘trickle down’ effect of the credit crunch won’t truly hit personal insolvency figures for the next six to twelve months as consumers in the UK turn from ‘lifestyle borrowing’ to ‘life borrowing.’

“The window of easily accessible, cheap credit available to most people 18 months ago is now long gone and consumers are struggling with high interest rates on their mortgages and loans and a squeeze on their discretionary spend. As a result, they are turning to more expensive means of unsecured borrowing such as credit cards, high interest loans and even pay-day loans (typical APR of 1845 per cent ) which will put further pressure on their outgoings and inevitably lead to insolvencies in the coming year.

“We are also seeing a shift towards the self-employed, sole traders and partnership businesses. These types of personal insolvency have been very much overtaken by the ‘consumer who has over-spent’ in recent years, but we expect to see a rush of small business related personal insolvencies coming through, particularly in the construction, retail and service industries.”