Britian’s Sinking Economy
I am not sure that British homeowners (myself included) and the general public at large are ready for the reality to come in the next few years. Especially since the Labour Party led by Gordon Brown seem to be completely incapable of doing anything to make the situation better; same for the opposition leader David Cameron and the rest of the Conservative Party who are all hype and no substance.
The credit crunch
Britain’s sinking economy
Jul 3rd 2008
From The Economist print edition
It is going to get nasty; exactly how bad depends on the Bank of England and, especially, Gordon Brown
The portents are increasingly gloomy. More and more signs are pointing to a punishing slowdown—with a recession looking likelier by the day. After 16 years in which Britain’s GDP has grown without halt, a downturn will come as a painful shock. Yet what may matter more is how Gordon Brown’s enfeebled government responds to the bad times ahead.
A stream of unwelcome news has reinforced fears that the British economy, still the fifth-largest in the world in 2007, is set to shrink. Those concerns were crystallised on July 2nd when two large firms reported serious setbacks. Taylor Wimpey, the country’s biggest homebuilder, revealed that it had been unable to raise the extra finance it needs to shore up its balance-sheet. Marks & Spencer, a food and clothing retailer, reported falling sales and Stuart Rose, its chief executive, gave warning of “stormy times ahead”. Both companies’ shares, especially Taylor Wimpey’s, tumbled heavily in subsequent trading, and the pound also fell in response as foreign-exchange dealers became more fretful about Britain’s prospects.
The markets are pinpointing two areas in which the economy is most vulnerable to a downturn: housing and retailing. Just as America’s growth has been dragged down since 2006 by falling residential investment, so Britain is now suffering a sharp contraction in homebuilding. That forms part of a broader slump in the housing market, in which turnover is shrinking because mortgage finance has dried up and house prices are tumbling (see article). Households are already being squeezed by the soaring costs of fuel and food. Now they are feeling even poorer as their homes fall in value, which makes them reluctant to shop.
Official figures, it has to be said, paint a more uplifting picture. The national accounts show GDP grew at an annual rate of 1.1% in the first quarter, a modest pace compared with the trend rate of 2.5-2.7% but some way from recession. Yet business surveys are signalling a downturn. Consumer confidence is at an 18-year low; for big purchases it has plumbed a 26-year low. And even if the official numbers turn out to be right, the prospects for both GDP growth and consumer spending look dire as living standards stagnate because of rising inflation.
Not just recession, M&S recession
Maybe the British economy will muddle its way through over the next year or two without going into recession; but it would be surprising if it did. Like other rich countries, Britain is feeling the downdraft from the credit crisis at a time when rising inflation makes it hard for the central bank to provide succour. But it is more exposed than most for three main reasons.
First and foremost, the housing bubble was one of the frothiest in the world. Real house prices increased by around 140% in the ten years to early 2007. In Spain (see article) and Ireland, where price gains rivalled Britain’s, heady housing-market booms have given way to bust. House prices in America are falling faster than during the Great Depression.
Second, British households are the most indebted in the G7, and the tide of cheap credit that caused the housing and consumer-spending booms has ebbed particularly fast in Britain. Within Europe, British mortgage lenders were especially keen on securitising home loans (pooling them to back bonds sold on to investors). The virtual closure of the securitisation market over the past nine months has thus had a disproportionately big effect on mortgage finance in Britain.
Third, economic growth was buoyed in recent years as the City thrived on the back of all the clever financial deals that have now come unstuck. An economy that came to rely as heavily as Britain’s did on finance is clearly vulnerable to an extended banking crisis. The era in which GDP growth was supercharged by a financial-sector boom is over.
From hubris to humility
Adapting to this new world will be hard. Business tycoons who grew rich on cheap, sound money will need new skills; so will David Cameron’s Conservatives, whose focus has been on social policy, not economics. But for Mr Brown, a stumbling economy will be an especially chastening experience.
When he was chancellor of the exchequer, inflation was low and stable, national output grew quarter after quarter, and year after year Mr Brown boasted of his brilliant management. Now his claims look hubristic. Indeed, public fears about the economy are the main reason why the Tories have surged in the polls. Having made his economic reputation in fair weather, Mr Brown must now cope with more troubled times.
Two temptations present themselves. One will be to mount a fiscal rescue package. If Mr Brown had fattened the public finances during the good times, as he should have done, then this would be no bad thing. Unfortunately, he did quite the opposite. And now the Treasury has bent its supposedly binding fiscal rules by borrowing £2.7 billion ($5.4 billion) this year to help tax losers from Mr Brown’s final budget. The government cannot afford more vote-pleasing handouts.
A further, and larger, worry concerns monetary policy. Siren voices are arguing for the Bank of England to cut interest rates again. It should ignore them. Consumer-price inflation is already at 3.3% and expected to rise above 4% (double the official target rate) later this year. Britain’s economic prospects already look bad enough. Letting inflation escape would cause even more pain in the long run. The abiding lesson of monetary history is that the higher inflation gets, the costlier it becomes to bring down again.
Therein lies Mr Brown’s second temptation. Making the Bank independent was one of his genuine achievements: he has no day-to-day control over it. But he could still influence outcomes by raising the inflation target and thus loosening monetary policy; and a government whose electoral prospects look as dire as this one’s do is bound to be tempted.
If Mr Brown succumbs to that temptation, he might pick up a few more votes at the general election due within the next two years—but probably not enough to win. And he would then go down in history as a prime minister whose tenure was as disastrous as it was brief.