Monday, August 24, 2009

It's all over, bar the firing

The crisis is over, and you may resume the seatedness of your posture. After all, you will have heard that Germany and France have officially pulled out of recession. Even Japan, which has been in terrible shape, is managing a recovery. Well, what else could Britain do but join in? Somehow it must be shown that the UK, too, is surging back to rude health. Today, a survey of business professionals reveals a sudden leap in 'confidence', thus proving that Britain's recession is "at an end". While there can be no doubt that various stimulus packages have pulled national economies back from the brink of outright catastrophe, it is difficult to take this air-punching, air-kissing jubilance seriously. Simon Basketter gives some good reasons to be sceptical of this optimism, pointing out much of the statistical boost arises because the collapse in exports was slower than the collapse in imports, thus boosting national income. Further, he notes, unemployment continues to rise and wages are still falling, (particularly in Japan).

Nouriel Roubini gives even more reasons to be cheerless:

Employment is still falling sharply in the US and elsewhere – in advanced economies, unemployment will be above 10 per cent by 2010. This is bad news for demand and bank losses, but also for workers’ skills, a key factor behind long-term labour productivity growth.

Second, this is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest.

Third, in countries running current account deficits, consumers need to cut spending and save much more, yet debt-burdened consumers face a wealth shock from falling home prices and stock markets and shrinking incomes and employment.

Fourth, the financial system – despite the policy support – is still severely damaged. Most of the shadow banking system has disappeared, and traditional banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalised.

Fifth, weak profitability – owing to high debts and default risks, low growth and persistent deflationary pressures on corporate margins – will constrain companies’ willingness to produce, hire workers and invest.

Sixth, the releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.

Seventh, the reduction of global imbalances implies that the current account deficits of profligate economies, such as the US, will narrow the surpluses of countries that over-save (China and other emerging markets, Germany and Japan). But if domestic demand does not grow fast enough in surplus countries, this will lead to a weaker recovery in global growth.


As for the UK, the Bank of England has pumped £175bn into the economy, and kept interest rates at historic lows of 0.5%. The total amount of money released into the economy under the policy of 'quantitative easing' is equivalent to about 12% of the UK GDP. The total spent on fighting the recession, including bail-outs, is £350bn, or approximately 25% of the UK GDP. Even with that, it is expected that they won't keep to the target inflation rate of 2% - prices will remain low because demand will remain weak. Despite an uptick in spending, borrowing has hardly increased. The reason for this is that banks are hoarding the money dished out by the Bank of England to protect themselves against future losses, rather than increasing lending. As Paul Mason points out, to save the City, economic recovery has been delayed. And when the recovery does come, it will be weak and fragile. (The Left Banker has a really splendid analysis of the figures).

There is also the additional complication of elections. The current state of UK public finances is, thanks to the bail-outs, very poor. The Tories propose, in the very likely event that they win the elections, to immediately embark on public spending cuts of at least 10%. Their more 'radical' councils are leading the way in this, with Barnet council slashing spending on sheltered housing, parks, libraries, welfare advice, etc. Both New Labour and the Liberal Democrats are also committed to cuts, even if the government faces some limited pressure from the unions on this point. But the Tories want to be very aggressive about this once in office. They want to start the cuts much earlier, go much deeper, and I suspect that they want to take on the public sector unions in a major way. To attack public spending at a time in which unemployment continues to rise, and in which demand remains weak is, as the MPC's David Blanchflower argued, a sure way to scupper any potential recovery. But it wouldn't be the first time that the Conservatives have preferred a deep and painful recession in order to weaken and attack the labour movement.