Monday, 18 July 2011

Austerity Has Failed - Part 2

The economic consequences were inevitable. Even though, the Cuts were back-loaded, by not starting to be implemented until 2011 as the Liberals had argued for, and the majority of the Cuts in terms of Welfare and Benefits spending, pushed back to 2013, the continual repetition of the idea of an existential threat, could have no other consequence than to cause consumers, and many businesses to go into shut-down mode.
The fiscal expansion, introduced by Labour, continued to feed through for a couple of months, but by the Third Quarter of 2010, growth had already slowed virtually to a stop, and by the Fourth Quarter it had, as I had forecast, gone into reverse, falling 0.5%. That in itself should have been a warning sign of just how sharp the reversal was.

In the First Quarter of 2011, growth largely just recouped what it had lost in the final quarter of 2010, partly fuelled by Christmas, and inventory restocking. But, the only growing part of the economy was manufacturing, which itself was based on a 25% devaluation of sterling, which acted as a one-off boost to competitiveness. But, accounting for just 12% of the economy, even strong growth there was not going to drag the economy out of recession, especially when, as was not hard to foresee, UK export markets were themselves going to decline as the same austerity measures in parts of Europe took hold.

Some time ago I suggested that growth in the Second Quarter would be around 0.2%. I think, on the basis of recent data, even that now looks optimistic. I think, that growth in Q2, is now likely to come out at somewhere between minus 0.2% and plus 0.1%. I also expect that the final reading for Q1 GDP will be revised down further. The Tories argued that, by introducing austerity, Capital would flow from the Public to the private sector. They have pointed to the number of new jobs created in the last year as evidence of that happening. But, many of those jobs are part-time jobs, and during that time the real cuts in Public Spending have not been introduced.
Its true, that Germany has also introduced austerity measures, and has continued to grow rapidly, but that is precisely the point. The German economy was already fundamentally sound, and competitive. It introduced expansionary fiscal policies, largely via the automatic stabilisers in the economy, that quickly turned around the sharp declines caused by the recession. Its economy is more than able to deal with austerity measures, precisely because it is growing so strongly!

But, those same measures applied to economies that are not fundamentally sound, that are not globally competitive, and need to restructure and grow, is suicide. It is like telling someone in the middle of having a heart attack, to start jogging! What is worse, given the context of the EU debt crisis, such a policy, will, by leading to a default, in Greece, and possibly other countries, such as Ireland and Portugal, create a second Credit Crunch, sending the developed economies into a serious recession that they now have far less tools available to deal with, given that they used them on a large scale to deal with the last.
To continue down that road would be economic madness. Every serious economic commentator knows that, and even the right-wing journalists on US business channels like CNBC are now saying openly that what needs to happen in Europe is for the issuing of EU Bonds, for the EU to buy up peripheral debt, and write it off, and that what is stopping that is political stalemate within the EU – what has come to be called in Germany “Merkelling”, i.e. political dithering.

In Britain, we have further evidence of just how devastating the Liberal-Tory policies have already been. The other day, I was in Stone with my wife. Stone is half-way between Stoke and Stafford, a small market town, whose MP is Bill Cash the Eurosceptic Tory. That reflects the middle class nature of much of the area. My wife likes to have a look in the Charity shops there, because you tend to get better stuff being cast-off in such areas. And, in fact, the High Street is full of almost every Charity Shop you can think of.
At the same time, many of the other shops have either closed down, or like Ethel Austin, were having closing down sales. Others, have what seem like constant sales, with large discounts. Watching TV at the weekend, I was struck by the number of other adverts from big stores offering 60, 70 and more percent discounts in current sales. And, we have already seen groups such as T.J. Hughes go bust, with many more in serious trouble.

That picture is reflected in the views of the Federation of Small Businesses, typical of those core Tory members and voters, who have today called for a reduction in VAT to just 5% for the Construction and Tourism industries. The BBC, report that the FSB survey shows significant falls in confidence by small businesses throughout the country. But, the worst area is in the North-East, which as I pointed out in my blog Economic Theory And The Cuts, was bound to be the case, because, in areas where Public Spending is more important to the economy, the multiplier and accelerator effects will be more pronounced than those areas with an already thriving private sector. The FSB say that consumer demand is disappearing, and that is particularly pronounced in the housing market, where the bubble in house prices means that first time buyers cannot afford to save a deposit, and existing homeowners find that the home they want to move to has leapt way beyond their reach in the last ten years of rapid price rises.
70% of homes put up for sale have still not been sold, say Rightmove, according to the BBC. That can be seen almost everywhere other than London, by casual observation. I have seen two houses nearby reduced in price by £40,000 recently, and one of those still didn't sell. According to Rightmove, house price increases have been outstripped by inflation by 14% in recent years. They say this improves affordability, but, of course, it doesn't. If wages had risen by 14% above house price rises, that might be true, but wages far from rising, have been falling. Falling wages, and rising inflation, for things that people have to buy, means less disposable income to save for a deposit, or to pay for a mortgage. And that is with interest rates at record low levels. In 1990, the onset of a new recession, and the rise in interest rates, were the cue for a 40% reduction in house prices. Then house prices were just 20% over priced according to the OECD. Now according to the OECD they are 40% overvalued.

That is reflected in the huge and widening gap between the asking prices that the media usually focus on in their headlines, and the actual selling price of those houses.
This month, the BBC have done a good job in highlighting that difference on their website. They point out that the average asking price according is £236,597. However, according to the Department of Communities and Local Government, which compiles data on actual selling prices via the Land Registry, the average selling price is £203,528, meaning that sellers and estate agents are overpricing houses by around 16%. But, as the BBC points out the situation could be much worse than that. They say,

“The reality gap is even greater when asking prices are compared to house prices as calculated by the Halifax or the Nationwide.

The Nationwide says the average house now costs £168,205, while the Halifax says they cost £163,049.

That puts the reality gap at 41% based on the Nationwide's figures or 45% on those from the Halifax.”

They quote, Miles Shipside from Rightmove, who says,

"Many equity-poor aspiring sellers will be trapped in their current homes, either unable to come to market or stuck on the market and unable to reduce to a price that will attract buyer interest," explained Miles Shipside of Rightmove.

"With seven out of ten properties marketed so far this year still on the market, sellers in the second half of 2011 need to do something different to promote their property and increase their chances of catching those elusive buyers."

But, in fact we have seen this before, and the consequence for many is not that they are trapped in their current homes, but that they are evicted from them!
In 1990, many people who had bought towards the height of the market, found that as mortgage rates rose from 7% to 15%, they were unable to make their monthly payments, even more so if they lost their job. Finding themselves in negative equity, there was nothing left to do, but to move out, and into rented accommodation. Banks and Building Societies put the houses up for auction, for a quick sale, which further depressed prices. A similar process has been underway in the US, over the last two years, with house prices falling in some cases by as much as 75%, as I showed recently. Ireland has seen falls of 60% in a year.

Of course, not everyone will be affected like that. Those who bought more than ten years ago, provided they have not re-mortgaged, will still have a house worth more than their mortgage, even if prices fall by 50% or more. Those who bought in the 1960's and 70's would be in that position even with a 90% fall. But, with the outcome of the debt crisis in the EU still uncertain, with the austerity measures there and in Britain driving the economy into the ground, with rising inflation, and the inevitability of rising interest rates as a consequence, as Bond buyers demand a higher return to protect them from that inflation and risk, the probability that the housing market is going to get badly hit, in coming months, is exceptionally high. Past experience suggests that procrastination would be fatal. If sellers want to avoid having their houses sold from under them, then they should consider selling now at almost any price.

No comments: