Goldman Sachs strikes back; IMF paratroopers bail out over Greece; the media celebrate soaring house prices; and also tell us the UK has avoided a double dip recession. The four big stories of the weekend are related. This is what happened, and why a lot of hogwash has been pouring forth.
That great barometer of the UK economy is set fair again. Later this week, the Nationwide is set to release its monthly housing survey, and most expect its data to say house prices rose 10 per cent over the last year. Both the Mail and the Express gave advance warning of this expected news over the weekend, with the Express splashing the story over its front cover.
Meanwhile, other sectors of the media are lamenting the latest figures from the ONS that the UK economy grew by only 0.2 per cent in Q1. They say, oh dear, what a blow. Others express disappointment with the figures, but then say that at least we managed to avoid a double dip recession, that was the real worry. They go on to say the UK has passed the danger point, and fears of a double dip recession are over.
But they are wrong, all of them. And they are wrong for lots of reasons.
The great squeeze
Only an election separates us from the great fiscal squeeze. If the Tories win, the squeeze will begin in earnest on day one. If Labour wins, the squeeze will be almost as tight, but maybe not quite so earnest. If the Tories win, spending cuts will be the main focus. If it’s Labour, the spending cuts won’t be quite so radical, and taxes will rise. Both agree on more taxes and less spending, but they disagree on the balance between the two.
The Tories make the common sense argument. If a business or household is short of money, it needs to make cut backs. The flaw in the argument is that when we are talking about governments, the story changes. If government cut backs are too severe, job losses will become a major problem. Workers who lose their jobs will spend less; the businesses that used to sell to the workers who lost jobs will make less money, so they too will be forced to make cuts. The economy could fall into a downward spiral, tax revenue would fall, and the consequence of government spending cuts could be even greater government debt. This scenario is not controversial. All accept that this can happen. The disagreement is over whether we are at that point now, in which case spending cuts will have this adverse effect.
In an environment in which demand exceeds supply and there is little spare capacity, government cuts can free up labour, which will then be employed by industry in areas where labour is desperately needed. But we are patently not in that environment. Instead, industry has oodles of spare capacity. The surprise of the recession was the modest level of job losses. The price we paid for this was falling productivity. There is little demand for new labour. It doesn’t matter if government spending is inefficient. Cuts means jobs losses. And in an environment in which there is so much spare capacity, job losses will mean higher unemployment for quite a while.
So, yes, government cuts are unavoidable, but the price we pay will be higher unemployment and lower tax revenue.
The alternative is higher taxes. This is the preferred Labour approach. But this means our affordability is squeezed. We will spend less, so aggregate demand will fall. The rise in NI will reduce employers’ incentive to recruit. The perverse consequence of a tax rise is that tax receipts may fall.
Whichever way you look at it, the next government, whoever that is, is stuck between an economic rock and a fiscal hard place. There is no easy solution.
That is why claims that the UK is past the worst, and that the real danger was of a double dip in Q1 of this year, are complete rubbish.
ONS data misleads, and so does housing hype
In fact, when the ONS finishes revising its data for Q1, it seems likely that growth will be upgraded significantly. Those who proclaimed woe on how disappointing the first set of figures from the ONS on Q1 are, will almost certainly be left with egg on their face.
But equally, those who say we are past the worst and from now on in we can look forward to growth, may also be proven wrong.
The Mail and the Express celebrate the likelihood that the Nationwide data will show annual house price inflation is now 10 per cent. As if that’s good news. We are set to enter a period in which government austerity is guaranteed. If markets start fretting over the government’s ability to repay debt, interest rates will shoot up. As we enter this period, average house price to average income is too high. This means we are more vulnerable than ever to a housing crash, and as economists now surely realise, falling house prices creates all kinds of economic fallout. And yet the Mail and the Express celebrate that house prices are rising to even higher levels.
The higher they rise, the further they will fall. In early 2008, a survey from the Halifax revealed that while house prices were falling month on month, the annual rate was still positive. The Express ran a lead story celebrating rising house prices. It was an extraordinary moment. The point when madness of the crowd had surely reached a level which showed the economic lunatic asylum was full.
The US could fall sick again, and not even blaming Goldman Sachs can help
In the US, the inventory of unsold houses remains way too high. Foreclosure rates are surging again. A second dip in US house prices seems inevitable. The first US housing crash created the credit crunch. The mind boggles at what the second crash could create.
And still we look to blame the banks. Goldman Sachs has issued a robust rebuttal of the charges laid against it. But its key argument is surely that the bank made a $1.2bn loss from subprime. If the bank deliberately sold securities it knew were going to fail, so it could bet against them, then explain how the bank lost money?
The casino banking we now castigate was not casino banking at all for as long as house prices went up. Mortgage securitisation was supposed to reduce risk. The IMF hailed it as a key innovation in reducing financial risk. Banks paid out huge bonuses to staff who helped to promote a lie. But the bank did not realise it was a lie. Was their remuneration any more immoral than the wealth earned by people who did nothing more than live in a property that grew in value, and then spent the profits by taking out a top-up mortgage. They too benefited from an illusion of wealth creation that eventually created an economic crisis. And like the banks, they too were bailed out, in their cases by interest rates close to zero.
Greece needs to beware of IMF bearing gifts
And now Greece finally avails itself of IMF money. “Don’t worry, we are not that nasty organisation that created problems for the Asian Tiger economies 13 years ago,” says the IMF. “We are all soft and cuddly now.”
But borrowing money when you are in debt is no long-term solution. Greece’s problem is that markets demand interest rates of approaching 10 per cent on government bonds; the IMF/EU loans will cost around one-third that much. But still Greece is not competitive. It can’t afford the euro, because it needs a cheaper currency than Germany. It can’t afford to leave the euro, because it would lose the backing of its partner countries. Greece’s only hope is in its labour force accepting lower wages. Not likely. And as the great Greek bail out unwinds, all eurozone countries chip in, meaning Portugal, Ireland, Italy and Spain find themselves contributing the money they don’t have. Today’s Greek crisis is tomorrow’s EU crisis.
The danger, the get out clause
The danger of a double dip recession was never in the quarter just gone – it lies in next year.
The UK’s big hope comes from the cheap pound. Surveys from CIPS/Markit and the CBI suggest the export sector is growing at a record pace.
But weakness in the Eurozone and the US could change the picture. And that is why spring may yet turn to winter, and bypass summer altogether.
But hope has not yet returned to the economic Pandora’s box. It is out, along with all the economic ills. Hope comes in the form of the extraordinary rises in US productivity, which at least in part are down to new technology. But rising capacity must be met by rising demand. And it seems we are set for a new consumer electronics revolution too, with 3D-TVs, a new generation of smart phones, and the iPad type products that mean the dream of a PC on every desk has been replaced by the dream of a PC in every room in the home. This new revolution has already begun, and is reflected in the stunning corporate results coming out of America recently. This could provide the foundation of sustainable growth, and with growth fiscal debts become manageable. It seems we may yet innovate our way out of disaster.
© Investment & Business News 2013