Friday, 25 February 2011

Economy Sinking Into The Mire

The revised figure for 4th Quarter GDP has come out even worse than the initial reading. According to the ONS, the economy shrank, in the last three months of 2010, by 0.6%
, as opposed to the 0.5% previously thought. When the initial figure was released a month ago, there was widespread shock. In fact, as I pointed out in my blog Tory Stagflation Returns, I had pointed out as far back as the end of October, in my blog Economic Theory & The Cuts, that “...I expect the economy to contract or be flat in the Fourth Quarter.”

In my later blog Economic Pressure Mounts On Coalition, I once more argued,

“In addition, economists are now expecting Fourth Quarter GDP to come in at just 0.4%, or about half the Third Quarter Figure. That decrease is an indication of how rapid is the slowdown. In fact, I would not be surprised to see Third Quarter GDP revised down again yet, and would also not be surprised to see Fourth Quarter GDP come in somewhere between flat and 0.2%. Even if the consensus figure is correct, it means that we are almost certainly heading for negative growth at the beginning of 2011, just on a trend basis. But, none of this reflects the fact that so far this dramatic slowdown is only a result of the Liberal-Tories talking the economy down for most of the year. It does not yet reflect the consequences of the Liberal-Tory Cuts programme, or of the tens of billions of pounds to be taken out of the economy in increased taxes from VAT, to Fuel and other duties, to National Insurance increases that they have been quick to impose on workers whilst giving employers a free ride.”

As suggested in those posts, the prospects for the First Quarter of 2011, do not look good. January could at best turn out to have been a wash. At the beginning of the month, Retail Sales appeared to pick up.
But, that mostly just reflects some borrowing of sales from December and the later part of January and beginning of February. In December, Retail Sales had been terrible, only in part due to the weather. At the beginning of January consumers, therefore, made up for some of the shopping they had not done before Christmas, and attempted to get in before the increase in VAT, from 17.5% to 20%. But, likewise, the sales at the beginning of the month, probably led to reduced sales towards the end of the month, more or less cancelling each other out.

There are good reasons why Sales will have declined, and continue to decline that have nothing to do with the weather or the VAT rise. In December, the UK Services PMI stood at just 49.7. Any figure below 50 indicates a shrinking economy. That was the worst figure for 20 months, back down to where it was at the height of the recession. In January, the figure did bounce back to 54.3. However, the average over the six months is only 52.5, which is consistent with pretty much flat economic activity. In reality, the January PMI figure, may turn out to be optimistic, based on a rebound in activity at the beginning of the month.

As set out in those blogs, the slow down in economic activity in the last half of 2010 was marked, compared to the unspectacular, but steady and rising growth of the first half, and compares badly with other economies such as the US, where large fiscal stimulus policies have been put in place, similar to that introduced by Labour. The reason for the slow down being so marked, even before the Liberal-Tories Cuts programme has been started, is to do with what Keynes referred to as “animal spirits”. In the run up to the election, and afterwards, as the Liberal-Tories hyped up the dangers of the deficit, ridiculously comparing the UK's position to that of Greece, and suggesting that the country was about to go bankrupt, with the bailiffs coming round to turn us all out, ordianry people understandably took fright.
If things are that bad, they thought, its time to batten down the hatches. For years, people had been encouraged by a consumer based society to think that there was something not quite right with you if you did not have a burning desire to engage in “Retail Therapy”, to have 100 pairs of shoes in your wardrobe, to just have to have the latest fashion with the latest designer label, the latest mobile phone, the latest gizmo of whatever kind, whether, your existing ones were still usable or not, whether you needed any of these things or not. And, with real wages stagnant for many ordinary workers, the way to pay for all these things was via increasingly available credit, and of course, there were no shortage of adverts encouraging you to take out a loan to buy a sit on mower to cut the grass on your couple of feet of lawn in front of the tiny house, you had been encouraged to buy, with the 125% mortgage, based on no proof of earnings, up to 6 times what you told them those earnings might be. That process had started in the late 1980's, when the Thatcher Government, had deregulated all Financial Services in the so called “Big Bang”, and had begun pumping out huge amounts of money to encourage such borrowing and spending to prop up the economy.
It was continued by the following Governments, afraid to stop the ball rolling once it had gathered momentum, and when every attempt to slow it down led to a crash on the Financial Markets.

But, after 2008, the ship had sailed. Now, telling consumers off for how frivolous they had been, borrowing all this money was the order of the day, and that fitted with the Liberal-Tory narrative of blaming Labour for deregulation, and for encouraging such wantonness. Again, it was not surprising that having been told all the borrowing and reckless spending had to stop, people took heed. Now was the time, to pay down your debts if you could, to put some money aside, as a precaution for the whirlwind that the Liberal-Tories, had been telling us for months would be coming along. Its no wonder that spending slowed down. And now, that has become self-reinforcing. Every day people see factories and shops closing.
They have seen jobs disappear, where they had been being created, and that is before the Liberal-Tory Cuts have begun.

But, even if Retail Sales were slightly higher at the beginning of 2011 the consequences of that for economic growth may not be much. A huge amount of the goods produced that are sold in those shops are imported, so the economic activity the sales produce is largely reflected in economic growth in China, or some other country, not in the UK.

Looking forward, things do not seem likely to get much better. According to ONS,

“The employment rate for those aged from 16 to 64 for the three months to December 2010 was 70.5 per cent, down 0.3 on the quarter. The number of people in employment aged 16 and over fell by 68,000 on the quarter to reach 29.12 million. “


“The number of self-employed people fell by 49,000 on the quarter to reach 3.98 million. The number of employees and self-employed people who were working part-time because they could not find a full-time job increased by 44,000 on the quarter to reach 1.19 million, the highest figure since comparable records began in 1992.“

The Employmnet Rate, as I've pointed out previously is more significant than the Unemployment Rate. In an expanding economy with more people being employed, it is still quite possible for the percentage of unemployed to rise. When the actual number of people being employed falls that is bad news, because it means that there are absolutely fewer people producing, paying taxes, and earning money to spend.

The only bright area of the economy is in manufacturing, but it now accounts for just 12% of the economy. Even if it were growing at 10% a year along the lines of a China, it would still add only a bit more than a tenth of a percentage point per month to GDP. Moreover, much of that growth has come from manufacturing exports that have grown strongly due to a 25% fall in the value of the pound. Even so, the growth in exports has not been anywhere near the kind of stella rise that the Liberal-Tory scenario for escape from the crisis requires, and, in fact, despite the falling value of the pound, the rise in Imports has almost matched the rise in Exports. Furthermore, the rise in Exports has come at a time when the world economy has once more been in a period of strong growth rebounding from the recession of 2008/9. It seems unlikely that that level of global growth will be sustained.
China is already tightening Monetary policy, and with rising uncertainty in the Middle East and North Africa (MENA), the revolution in Libya, and shut off of large amounts of oil sending oil prices well over $100 a barrel, a further large obstacle to growth has been laid down.

The UK's largest trading partner remains Ireland, and the consequence of Ireland's own austerity measures is to shut down a large portion of its domestic market to UK exports.
In fact, Ireland is itself attempting to resolve its problems by exporting to the UK, and another element of that will be to attempt import substitution. Moreover, it is apparent that the terms of the EU bail-out are too onerous for Ireland to comply with. Fine Gael is already saying the terms will have to be renegotiated, and its partners will push it harder to do so. Already, the idea that Ireland should follow Iceland's example, and simply default on its debt is being floated. That would almost certainly not be allowed by the EU, but if it happened it would have severe repercussions for Ireland within the EU, and for those UK Banks, and the UK Government that have lent it large amounts of money. But, Ireland is not the only economy suffering from austerity measures. The same is true in Portugal, Greece, and Spain. In the coming months, the consequences of that will be felt much wider than in just those countries, and the effects on the UK's potential exports will be one of the casualties.

At the same time, workers and those dependent on Pensions and Benefits are already seeing a significant reduction in their income as a result of stagnant or falling wages, and the sharp rise in inflation.
That means that alongside a challenging environment for exports, the major area of Aggregate Demand – Consumer Spending – is likely to be hard hit in the next few months. That is likely to be hit further as rising inflation feeds through into higher interest rates. As I reported a while ago, Fixed rate Mortgages for periods of more than 5 years – and there is litle point fixing for less than five years – have effectively disappeared. Increases in the yield on the 10 year Gilt are already rising sharply, and this is more significant than whatever the Bank of England does, because it is on these 10 Year Bonds, that the Banks and Building Societies borrow, and which determine their mortgage rates. I was talking to an old friend of mine the other day, who is a gardener. He works at a range of properties throughout the area, and is in a good position to keep an eye on what is happening. He told me that in one area, he was now seeing terraced houses up for sale for £35,000, whereas until recently they have been selling for closer to £80,000. He also told me about some new houses where one customer had complained that she had paid quite a high price, but the builder had been unable to sell the other hosues, and they were now rented out to people on Housing Benefit. A further problem that is arising now is that where people have taken out short term fixed rate mortgages, they are now finding that when they come to renew they are having to put down large extra amounts to cover the fact that the house is now worth significantly less than when they took out their mortgage a year or so ago.

With house prices already in a strong downward trend, the incease in interest rates will speed up that process considerably, and the wealth effect will mean tht people will cut back their consumption, and have to incease their savings even further.

In short, the GDP figure for the First Quarter of 2011 is not likely to show a great deal of improvement, on the Fourth Quarter of 2010. With the Liberal-Tory Cuts starting to take effect from the end of next month, with rising unemployment, large cuts in Capital Spending, and further increases in taxes to come, it is likely that the months into the Summer are likely to see an even greater deterioration.

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