Saturday, 4 October 2014

The UK Economy Is About To Turn Down Sharply

He thinks he'll be back after the next election.
The UK economy seems to be growing strongly. The GDP figure, for the second quarter, was even revised higher, from an initial reading of 0.8% to 0.9%, 3.2% as a year on year figure. Unemployment has been falling, and the number of people employed increasing. Inflation has been below the 2% limit, and interest rates are at 300 year lows. The Tories are able to crow about these facts, claiming that they are the result of their illiterate policy of austerity, and are counting on it to provide them with an election victory. They are going to be very disappointed, as the UK economy is about to turn down sharply.

The apparent rude health of the UK economy is a mirage. Let's look at the background, and the components. First of all, as set out on this blog many times, going back more than 200 years, the global economy goes through an approximately 50 year long wave cycle. It boomed for 25 years after 1949, then it slowed for 25 years after 1974. It has been in a long wave economic boom since 1999. The main beneficiaries of that boom have been the new dynamic economies like China, and now the developing sub-saharan, Africa economies, as well as those economies that have done well from providing vast quantities of raw materials to China. But, that boom has also benefited the existing developed economies, like the US and UK, and more specifically Germany. Germany has provided China and other developing economies with advanced machine tools, as well as high quality goods such as luxury cars.

The Trotters were a symbol of
the economy the Tories created
in the 1980's, where "Only Fools
and Horses work", and where every
one is encouraged to believe in get
rich quick scams, like property
That the US and UK have not fared so well during this period is because they are relatively declining economic powers, in the new global environment. Unlike Germany, in the 1980's and 90's, these two economies, settled for trying to protect the interests of the inefficient, small business sector of their economy. What they should have done is restructure, to take advantage of the changing conditions, for example, by investing in the education and training of their people, and the development of new high technology industries, where they could have a comparative advantage against economies like China. That is more or less what Germany did. Even where the UK and US did encourage people to go into higher education, they did so by encouraging them to load up with vast amounts of student debt to pay for it.

In contrast to Germany, the US and UK introduced measures of deregulation that exempted small businesses from having to comply with even the most minimal requirements that should be expected of a business in the modern world. An example, was the introduction of Enterprise Zones by the Tories in Britain. Rather than encouraging quality and higher value, it was an attempt to encourage a race to the bottom based on being cheap and nasty. The Tories recent proposals for providing cheap and nasty housing today, by encouraging builders to build on brown field sites, where no one wants to live, and allowing them to cut corners on basic regulations, is another example of that.

At the same time, the state acted to weaken workers ability to defend their living standards. Large numbers of workers from skilled jobs were thrown on to the scrap heap, and in the place of these jobs, came a load of low status, low paid jobs that were frequently either temporary or insecure. That process has continued, and reached its peak with the tens of thousands of people that are forced on to zero hours contracts, that tie them down from taking on other employment, but with no guarantee of any income.

As incomes fell, the only means of maintaining living standards was to take on huge amounts of additional debt. Thatcher and the Tories encouraged that by also deregulating financial markets. Both the US and UK have built up astronomical levels of private debt on mortgages, credit cards, student debt, and much worse, in the following period. It is about four times the amount of government debt the Tories keep whining about. It was this build up of private debt, and the deregulation of financial markets, carried out by Thatcher and Reagan, that led, in the end, to the financial crash of 2008. It is those policies of focussing on low wages, a failure to invest in developing skills, and high value industries, and the encouragement of debt that also explains why the apparent health of the UK economy is a mirage, and about to be revealed.

Within the context of this long wave boom, there is also a three year cycle, during which growth rises faster for two years, and slows for about a year. This is not necessarily a fall into recession, just that growth slows down. This cycle can be seen going back at least thirty years. It can easily be seen across, the globe, in slowdowns in 2002, 2005, 2008, and 2011. On this basis, I predicted some time ago, that a new slowdown would begin in the third quarter of 2014. It has begun. Growth has noticeably slowed in China, across a range of emerging market economies, and across the EU, including Germany. Not only have the economies in these countries slowed, but the survey data indicates that this slow down is set to continue and deepen.

Given that the UK conducts 52% of its trade with the EU, its fairly clear that such a slowdown in the EU will impact the UK. The US is growing strongly at the moment. It had 4.6% annualised GDP growth in the second quarter of this year, but the US is also likely to suffer from the three year cycle too. The US is also responsible for another aspect of the general background that will badly affect the UK.

Interest rates have been falling for 30 years, because the rate
of profit was rising much faster than the demand for money-
capital.  The surplus money-capital has continually pushed
down rates.  Now that is reversing, and global interest rates are
For years, the US has been pumping trillions of dollars into the global economy via QE. It is now reducing that QE, and will stop altogether next month. As a result the dollar rises in value. That has already had an effect on many emerging market economies. Their currencies have fallen sharply against the dollar, pushing up the prices of their imports, causing inflation to rise. Fairly large economies like Russia, India, South Africa, Brazil and Turkey have been hit badly. That means they have had to raise their official interest rates. Whilst official interest rates, in the US and UK, are near zero, and crucifying savers, official interest rates in these other economies are between 9% and 12% and rising. At some point money-capital is attracted by these higher rates from elsewhere, which means the economies it has come from themselves suffer falling currencies, rising inflation, and have to raise their own interest rates. Its a process I've described as volley-firing.

That is just official interest rates. Market rates, the rates that borrowers actually have to pay in the market, are rising across the globe, and sooner or later that will feed back into the weaker economies in the EU, like Greece, Spain, Portugal, Italy, that are still mired in massive amounts of debt. That debt presents a life threatening risk for European banks, who hold it. Again that is a big problem for the UK, because of the size of UK banks and their massive exposure to all of this European debt. It is also a major threat to the UK, because its economy has continued to depend upon individuals going into massive amounts of debt, and the blowing up of bubbles for property and shares etc., and that can only last for so long as interest rates stay low.

The final part of this picture is that as the value of the dollar is rising against the pound, that pushes up the price of UK imports of things like oil and gas, raw materials and food, which are priced in dollars. That means that where the UK has benefited from a weak dollar in the last couple of years, which pushed down inflation, that is going into reverse. Wages are already lagging way behind price increases. The problems faced by Tesco, and Sainsbury's and other big supermarkets are an indication that underlying costs are rising, whilst sellers are trying to hold down their prices, causing profits to be squeezed. At the same time, the pound is rising in value against the Euro, which means that it becomes harder for UK firms to export to the EU.

So, looking at the elements of the UK economy in the context of this background shows just why the economy is really weak, despite the appearance, and why that means it is not in a good state to deal with the three year cycle.

If we look at the actual GDP figure, its apparently strong performance can be seen to stand on weak foundations. For one thing, although the UK economy rebounded strongly in 2009, as a result of the stimulus provided by the Labour Government, when the Liberal-Tories took office that sent that recovery into reverse. Their threats of austerity were enough to scare consumers and businesses into cutting back their spending. When, later in 2010, they began actually cutting spending themselves, that sent the economy back into recession. The UK economy performed worse than the US, and most EU economies as a result. A large part of the growth over the last year, is simply a matter of catching up for the poor performance the Tories imposed on it, as a result of austerity after 2010, and of being in the up phase of the three year cycle!

There are also other shaky factors that explain the growth. For one thing, faced with a housing market looking like it was about to crash again, despite record low interest rates, they threw even more money and bribes at it, to keep it afloat. For a few months, that worked to pull a few more bigger fools into a massively over priced housing market, and stimulating a slight increase in construction. But, even that has run out of steam. In most of the country house prices continue to fall, and now, even in London, asking prices for houses are falling. The UK property market is totally zombified. Its only a matter of when it collapses.

Another aspect of the shakiness of the GDP figure is shown by the role that Payment Protection Insurance compensation payments have played. Around £12.5 billion has been paid out in PPI compensation, and these payments have boosted GDP by as much as 0.7%! But, the majority of those payments have now been made, so that is money that will no longer be funding consumer spending, in coming months. When your economy grows because of one off things like compensation payments, you know its on shaky ground. Its just like the ambulance chasing, compensation culture the Tories have encouraged in general. Perhaps the Tories could encourage a few more claims for whiplash as their next means of boosting GDP.

Similarly, with wages continuing to lag way behind price rises, a large part of additional consumer spending has once more been financed by increased borrowing, at a time when the astronomical levels of debt, previously built up have not been reduced. Although the government brags about the level of official interest rates, that of course, only affects the rate people can get on their savings or annuities, and that the Tories friends in the banks have to pay. It has no resemblance to the interest rates that ordinary people pay to borrow money. To be able to take advantage of the Government's “Help To Buy” scam, for example, you have to be prepared to pay 6% p.a. mortgage rates. Credit card interest ranges from around 12% to 30%, with store cards even worse. Millions of families only survive by relying on such debt. Millions more are in an even worse state, dependent on pay day lenders charging up to 4000% p.a. Even the better off sections of the middle class are being squeezed, and are borrowing through providers of “posh pawn” shops.

All of this is borrowing consumption from the future. The more people go into debt now, the more they have to pay back with interest later, which means the less they have to actually spend. With global interest rates rising, the three year cycle about to cause unemployment to rise, more pressure on wages, and these massive levels of debt, this is a disaster waiting to happen.

This is made worse by the reality of the employment situation. An indication of the problem is given by the fact that the Government now takes into account things like prostitution and illegal drug trafficking. Its not that this amounts to a fiddling of the figures. Its that the increase in these kinds of activities reflects the reality of employment as increasingly shaky. The reality of Tory employment is that huge numbers of people, unable to obtain decent full-time work, have been forced into taking on these kinds of twilight occupations in order to survive. Large numbers of others are forced into taking on poorly paid, part-time and temporary work. That is only just about possible, because the Tories continue to provide subsidies to the small inefficient, small businesses via the welfare state.

But, rather like the situation with credit, there is a limit before this zombified economy explodes into a pile of dust. People can only continue to pay debt, by taking on more debt, until such time as they can no longer make repayments. When that happens, on a large scale, not only will the pay day lenders go bust, but those banks that have lent to them, in the money market, will take a big hit too, as will consumer spending. The recent case of Wonga's profit being wiped out, by having to wipe off the debt of 330,000 of its customers, amounting to £250 million, is an indication of that.

But, also the Tories plans to attack welfare benefits risk backfiring in this respect too. If you have taken on a part-time job, or become a “self-employed” window-cleaner, because you can then just about scrape by, with Tax Credits, Housing Benefit etc., the effect of the cuts to benefits will be likely to push you over the edge. At that point, large numbers of such self-employed people will flood back on to the unemployment register. What the Tories have created is something similar to what existed in Eastern Europe, a false impression of low unemployment that simply hides huge levels of under employment.

The indication of that under employment is the appalling performance of the UK economy in terms of productivity. Productivity measures the value of output of the workforce, against the amount of work done. As a result of the polices adopted in the 1980's, the low level of skill, and low level of value added by UK industry, means that productivity levels were in any case low, when they needed to be high to compete. But, with an increased number of people, working long hours, to produce goods and services, with low values, and many people under employed, that productivity has declined further.

On the one hand, the low productivity and low value of production is the reason that wages are low, which in turn is why income tax receipts have not grown, and the Tories have been unable to reduce the deficit, despite the austerity measures. On the other, as Marx and Adam Smith point out, low wages encourage those firms that rely on low wages to continue to exist. That is it encourages those small firms that are inefficient, and in low value areas. It discourages innovation to save on labour and raise productivity, and prevents capital moving to those areas where productivity and profits are higher.

UKIP is strengthening the euroseptic wing of the
Tories, which means they are being backed into a
corner of pulling out of the EU.  The threat and
uncertainty around that will weaken the UK economy
 further, while a withdrawal would destroy it.

Low levels of productivity not only mean that UK firms are less able to compete in the global market, it also means that, as the prices of inputs, like fuel and materials, rise, that low productivity causes unit costs to rise more, so that a further inflationary pressure is introduced. One of the main reasons productivity did not fall quite so badly as it might, in the UK, is that foreign firms like Honda, Toyota and Nissan set up shop here, in order to sell into the EU. But, the Tories threat to leave the EU now threatens even that. Another reason has been the importance of the financial services industry, but again, if Britain leaves the EU, that will move to Frankfurt, and Britain will be frozen out. The Tories have introduced three years of uncertainty in that respect, and the economic consequence of that was seen during the Scottish independence referendum.

So, we have a global long wave boom that provides a level of support for growth, but the UK is one of those old economies that is in relative decline, so it does not grow like a China, or an Ethiopia. We have a three year cycle that has already caused growth across the globe to slow, and is set to continue for another year. On top of that, we have a UK economy that did not take the measures to restructure and invest in skills and high value production, which is why, in those areas that are growing, it faces skills shortages. We have an economy where consumption has only been maintained as a result of huge levels of private borrowing that has grown to such a limit that millions are forced into debt slavery, borrowing from pay day lenders at huge interest rates. Defaults of payments are on the rise, and likely to result in an avalanche of bad debts.

On top of all that, we have an economy where a lack of previous investment means that productivity levels are low, and so profitability suffers compared with other countries. We are set for GDP to go sharply into reverse, in the next few months, for unemployment to rise, inflation to rise, interest rates to rise, debt defaults to rise, and for the prices of houses, shares and other such assets to crash.

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