Saturday, July 12, 2008

UK economy: between a rock and a hard place

CU has asked me to comment on his latest post on the UK's economic crisis. I'm flattered that someone thinks my opinion is worth anything, but here's my effort:

There's often a kind of self-destructive excitement as a crisis develops, as at the gathering of forces for a war. But the Rupert Brookes will be succeeded by the Wilfred Owens.

I have believed for about 9 years that we are in for an unpleasant time, and that is why I returned to the public sector pro tem at the end of 1999: I really did (and do) think that everybody should prepare for a storm. I have also been encouraging my clients to become/stay cautious, for the last 10 years. I thought we'd returned to sanity in 2003, when the FTSE had halved from its start-2000 peak, but off we went again. From my amateur perspective (and who exactly is an expert on the world economy?), the delay in facing economic reality has allowed the patient's condition to worsen.

Mark Wadsworth's opening comment here was "Sell to rent. Cash is King." Yes, I agree, at this stage. I was talking to my wife last year about selling the house (and, I think, the year before that) but personal circumstances and priorities often trump the cold financial calculations, don't they?

However, I don't think cash will be king for a long period. I can't see the government rapidly shrinking the public sector, and at the same time we shall see reduced earnings, more insolvencies and increasing unemployment in the private sector. The financial sector, which has helped our nation's books to nearly balance, is being hit in banking and investment now, and will (I think) be hit worse in future; that cow will yield far less milk to the Treasury, and so the budget will be even more unbalanced than it is today.

Europe seems keen to enforce a discipline on the Chancellor of the Exchequer, that it has been unwilling to emulate with respect to its own accounts for many years; if the EU continues to take such a rigid line, maybe there will be a tear in the EU fabric, along the line of the English Channel.

Meanwhile, I think Gordon Brown's reputation as a money manager is ruined. As has been said, he failed to fix the roof when the weather was fine. A playboy can seem a financial wizard as long as he keeps partying on his yacht, but the adoring guests will disembark when the holes below the waterline make themselves felt.

(I wonder what would have happened if the Conservatives had won again in 1997? Can we be confident that the consequences would have been better?)

To right the ship of State will take money, or (since we hardly know what faith to place in money any more) perhaps it would be apter to say, wealth. This, I think, is where the "cash is king" slogan will wear thin. At the moment, we see a devaluation/destocking in houses, cars, computers and other big-ticket items. It's a good time for Loadsamoney to go shopping, even if the price of his dried pasta is up 40%.

But when the stocks have been run down to match shrunken demand levels, and Loadsamoney's firm is on the skids, the game will probably change. RPI is on the up, but now the causes are more external than internal: we have forgotten the lessons of WWII and have become very dependent on imports of food and fuel, which are major components of those inflation indices that aim to reflect the circumstances of the ordinary person. So interest rate rises are unlikely to reduce the cost of such necessities, except indirectly insofar as they may help strengthen sterling; yet a weakening in sterling is the hope for our trade in manufactures (the pound has dropped 15% or so against the Euro, in the last year). Indeed, we seem to have a policy of shadowing the plummeting US dollar, as once we shadowed the Deutschmark; perhaps, perceiving this strategy, George Soros will stage another coup, to our country's cost, again.

If revenues are down because of recession (or the D-word), where else will the Chancellor find wealth to repair the yacht? More sale of assets to sovereign wealth funds (there goes the family silver)? More bonds sold to trade-surplus foreigners (but will they have the cash, at a time when their own economies may be slumping together with Western consumer demand)? (Perhaps they will, if the US insists on handing the Chinese mortgage bail-out money - see Mish!)

Left high and dry in public view as the tide of wealth recedes, will be the billions in cash held by the crafty, the nervous and the cautious old. And the subtlest way to steal it is by inflation.

I do not know what will be the best store of wealth when major inflation strikes. All the world's gold currently above ground could be made into a cube that would fit comfortably under the arches of the Eiffel Tower (and historically, a fair bit of it could have been found not far away from the Tour Eiffel, stashed away in French ceiling-bowl lights). The gold market is small enough to be a prey to manipulation both ways.

Perhaps a safer store of value would be NS&I index-linked savings certificates. If inflation gets too bad, the easy way out for the government will be not to launch new issues, and the old ones have a maximum term of 5 years. There could theoretically be a problem for investors, in the effect of inflation between the date of maturity and the date the money is cleared in the investor's bank account, but we must hope that the government will never permit a hyperinflation.

And I note that landowners such as the Duke of Westminster have rarely sold their land because of temporary monetary inflation. Even if house prices do decline towards 3 times earnings, they will always have a value, and if rented out, will create an income. Perhaps Mark's comment would then be reversed: buy to rent, not sell to rent. Even now, as many try to get out from under the mortgage trap, there are signs that renting out property is a promising sector, since (I understand) demand is increasing faster than supply.

I'd be interested to hear other ideas.


Guthrum said...

not sure advocating we should all rush to get public sector jobs is the answer, reducing the State and overblown state spending that is sucking cash out of the economy through incontinent spending is. We have an economy that just does not encourage saving


Guthrum, I did it for self-protection.

I left teaching in 1989 to become a belated Thatcher's child, joining an insurance company just in time for the torrent of economic problems and the mania for financial services regulation (a long story in itself, that). I had my go at trying to help ordinary people save for the future.

It seems that unless you're a spiv or expat millionaire, then to put it crudely, doing business in the UK sucks.

Mark Wadsworth said...

I wonder what would have happened if the Conservatives had won again in 1997? Can we be confident that the consequences would have been better?

Focussing on runaway house prices (my specialist topic), I think it would have been even worse.

Assuming that Tories had run slightly lower taxes etc, and bearing in mind their rampant NIMBYism and their role as front for the land-owning lobby, it is quite possible that house prices would have rocketed even higher - like in the Lawson boom and the Barber boom, i.e. the Tories are just as guilty of this as Nulab.

For example, see this exchange at St John of Redwood:

My comment: "John, agreed. But what we have now is the fall out from the housing and credit bubbles bursting. If you had stayed in government since 1997, hopefully you would have wasted less and taxed less. But - and this is the big but - wouldn’t lower taxes have had the effect of creating an even bigger housing/credit bubble? What would the Tories have done to prevent these bubbles happening? The previous bubble was under a Tory government, don’t forget."

John R's reply: "The previous bubble was thanks to the European policy of shadowing and then linking to the DM. A Conservative government would have spent and borrowed less."

Not much of an answer, is it?


Some rule on income multiples for borrowers would have been helpful.

And how about making lenders solely liable for the loss from a self-cert default, to the extent that (after auditing the case) the loan exceeded the regulatory multiple? Something along those lines.

Mark Wadsworth said...


So how does that deal with buyers who borrow money from their parents, (who themselves have remortgaged up to your chosen hilt) and who have maxed out on their credit cards? What about married couples? Should the bank assess the likelihood of Mrs having a baby and how long she might be off work?

To make this stick, you would have to include every penny of store card, credit card and family loan.

Whatever rules you dream up (and on a human level, I agree that they might make sense), people and banks will find a way round them.


Mark: I agree that you'll never eradicate folly, but making the lender liable for gross excesses would incentivise them to take more care.

Karl Denninger has pointed out that for Americans, if the lender colluded with the borrower to falsify information for the loan application, the lender is liable; and he's urged people caught in the mortgage vice to consult their lawyers and tax advisers on this point.