Like, I suspect, a lot of other doom ‘n’ gloom economic pessimists (and there are quite a few bears in this neck of the woods) the last few weeks have had me questioning my views on the British economy. Barely a day goes by when I don’t open City A.M. or the Standard, only to be confronted with improving economic data. Am I wrong? Should I sell my gold and silver, leave my mountain hut in Idaho and return to civilisation?
Bright spots exist in certain sectors of the economy, no doubt. The emergence of “Silicon Fen”, a tech hub in Cambridgeshire. All that shale gas in northwest England. The growth of alt-finance SMEs in London, and the revival of car manufacturing – led by the likes of Nissan and Jaguar Land Rover. On-shoring could lead to industrial recovery in the north. Of all places, the new town of Stevenage in my home county Hertfordshire is turning itself into a hub for space exploration technology. It’s also heartening to see steady growth over the last few months in manufacturing output.
But for me, none of this can cancel out the biggest problem with this recovery, which is that it’s totally reliant on rock-bottom interest rates and government/big bank schemes designed to push consumers into deeper debt, in order to finance lifestyles that they can’t really afford. In other words, a revival of the mindset and policies that led us to the precipice in 2008.
Average household debt now stands at £54,000 – double where it was a decade ago. London markets are now pricing in a 3% three-month sterling LIBOR rate (similar to the base rate) by late 2017. As the Resolution Foundation thinktank has warned, one million households would face perilous debt if rates rose to 3%, with two million forced to spend more than half their income on servicing a mortgage if rates returned to the 5% level common before the financial crisis in 2007.
People are yanking cash out of savings accounts at the fastest rate in 40 years in order to fund present consumption. This is having unfortunate consequences as far as private investment, the lifeblood of future growth, is concerned. I mentioned in a previous article, as Douglas Carswell noted in a City A.M. piece the other day, that the UK ranks an appalling 159 in the world when measuring investment as a share of national income. Lack of savings also has ominous implications for pensions. A recent study by Policy Exchange states that average savers have just £36,800 to pay for old age; well below the £240,000 needed for a decent retirement.
Given that the Bank of England’s low interest rate policies are all about stimulating present consumption at the expense of saving and deferred gratification, this problem can be laid squarely at its door (though Gordon Brown deserves a lot of the blame as well, given that independent research reckons his 1997 “stealth tax” on private pensions cost savers around £100 billion).
Though down from 160,000 in late 2012, there are still over 100,000 “zombie companies” – indebted, unprofitable firms kept alive only by low interest rates – employing around 500,000 people. Nobody wants to see people unemployed and firms go to the wall, but when considering the medium-to-long term health of the economy, it should be obvious that allowing the free market to reallocate capital trapped in zombie firms is preferable to allowing them to stagger on in perpetuity. But yet again, artificially low interest rates are dragging out this process, depriving healthier companies and prospective businesses of capital and potential employees.
No discussion of debt, interest rates and the UK economy would be complete of course without mentioning the banks. The other week – in news not generally commented on in the press – the Basel Committee on Banking Supervision, under intense pressure from bank lobbyists, announced a reduction in its advised leverage ratio. The ratio it now calls for is just 3% – barely above the 2% common to UK banks just before the last collapse. As the Telegraph’s Liam Halligan comments:
“The leverage – or loan exposure, for a given amount of capital – of Western banks has been rising steadily for more than a hundred years. At the end of the 19th century, British and American banks would typically hold capital equivalent to around 25pc to 35pc of their loans. Such banks could absorb losses up to a quarter or a third of their outstanding loans, then, and remain solvent.”
The Parliamentary Commission on Banking has called for a higher UK leverage ratio, but – surprise surprise – the government doesn’t seem too keen on the idea. Regulators and politicians are essentially giving the banks carte blanche to return to the carefree pre-financial crisis regime. Back to Halligan:
“At the same time, technical changes related to the ‘netting’ of derivatives and the treatment of off-balance sheet items will now allow banks further to reduce the capital they’re required to hold for a given loan/investment exposure. It’s precisely what the bankers wanted…
“The UK has adopted Basel rules, such as they are, earlier than most. Yet given our grossly-bloated banking sector, with a combined balance sheet equal to five times our annual GDP, we have the most to lose from changes such as these, which allow our already precarious banking sector to behave in a manner which is even more risky.”
Though the UK is an extreme case, Western economies have become reliant on banks finding ever-more ingenious methods of levering capital. Our post-sound money economies are based on exponential debt, as the chart below (for the US) shows. Note the ever-growing divergence between GDP and the size of the total credit market from the early 1970s, at the dawn of the floating exchange rate era.
No surprises then that Mark Carney is unenthusiastic about raising interest rates. He must know how dependent on cheap money the British economy has become. With each recession over the last 30-odd years, the Bank of England’s base rate has been driven to progressively lower and lower levels. Now here we are nearly two years from the formal end of the last recession, with no sign of any imminent rise above 0.5%.
What happens when credit markets tighten – perhaps causing another recession? With rates already at very low levels, the Bank will be forced to resort to more QE in order to juice the economy. Over time, instead of interest rate reductions, ever-increasing doses of QE will become its go-to solution for economic weakness. A slippery slope that ends in either a currency crisis, or an even bigger deflationary depression than would have occurred had the Bank allowed liquidations years earlier.
Sorry to resort to clichés, but kicking the can down the road really is the best phrase I can think of to sum up the situation. There are bright pockets of entrepreneurial genius in the UK, but not enough the mask the smell created by a flawed monetary system that encourages debt and consumption at the expense of saving and investment, overseen by self-interested bankers and politicians who can’t look beyond the next election.