Sunday 26 July 2009
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Sunday 26 July 2009 |
The political classes obsess over the Norwich North by-election and Labour’s slow-motion hari-kari under Gordon Brown. But the news that really matters – the economic news – keeps flowing thick and fast. And it’s far from reassuring.
UK output shrank 0.8pc between April and June - far worse than the average 0.3pc slump predicted by City economists. All parts of the economy - apart from the public sector - are now in recession.
This was the fifth successive quarter of GDP contraction, with output down 5.6pc since the spring of 2008 – more than double the depth of the early 1990s recession and the steepest peace-time fall since the early 1930s.
Serious financial obstacles prevent a return to sustainable growth. With the global economy still on the skids, demand in key overseas markets remains muted.
Far more significantly, though, UK banks continue to hold the rest of the country to ransom, refusing to extend credit on reasonable terms, despite replenishing their balance sheets off the back of taxpayer largesse.
Regular readers will know what’s coming next. But repetition doesn’t make a fundamental truth untrue. The UK’s inter-bank market remains gridlocked largely because banks are still unwilling to lend to each other. That gums up the wheels of finance, starving credit-worthy firms and households of the cash they desperately need.
This inter-bank torpor stems from fear of counter-party risk, because our banks continue to sit on billions of pound of toxic liabilities which they still refuse to reveal.
A wiser government, a braver government would have forced the banks to “fess-up” these losses before splashing the “bail-out” cash, so purging the system and allowing a genuinely restructured banking sector to dust itself down and start again. It’s called “creative destruction”. It’s not pretty, but it’s the only thing that works.
These GDP numbers expose the City’s talk of “green shoots” as nonsense. A full recovery won’t happen while the UK remains burdened by our newly-created Japanese-style “zombie banks”.
This is the heart of the problem – yet the politicians don’t want to know. The banks are ticking over on a diet of government cash while charging usurous rates on extremely limited lending books. The UK, meanwhile, sleepwalks towards a “lost-decade”.
As the economy stagnates, unemployment rises and the national accounts bleed ever more red ink – as revenues collapse while government spending goes up. New figures show that in June, tax receipts were 8.2pc lower than the same month the year before, while social security benefits were 9.7pc higher.
In any downturn, the public finances suffer, as tax and spending pull in opposite directions. But the bank rescue packages and the depth of the current recession are tearing the UK’s national accounts apart.
In his 2008 budget, Alistair Darling said he’d borrow £70bn during 2009/10 and 2010/11. In this year’s budget, the Chancellor admitted no less than £348bn of extra debt would be racked up during that period – an astonishing five-fold increase on his forecast of 12 months before.
But even that jaw-dropping increase was an under-estimate – because Darling’s borrowing predictions are based on the UK economy shrinking only 3.5pc this year, then returning to growth of 1.25pc in 2010 and 3.5pc in 2011.
When these projections were published three months ago, this column dubbed them “ridiculous”. Given how growth has fared since, they now look even worse. So the UK will borrow even more this year than the £175bn announced at the last budget. No wonder the gilts market is so spooked.
While admitting fiscal consolidation is needed “at some point”, politicians from all main parties drone on that the UK’s national debt, while sharply up, is “only” around 56pc of GDP. “It’s much higher in the US, Italy and Greece,” they say.
Fetch my revolver. Do these people not understand that insolvency relates not to the stock of debt, but to cash flow? And as spending rises and tax receipts fall, cash flow is the issue upon which the gilts market is now very firmly focussed.
The UK is issuing more debt as a share of GDP than any major economy. We’re borrowing twice as much in 2009 as France and Germany. In recent months, banana-republic style, the Bank of England itself has bought around half of all gilts issued.
Then on Thursday, following the biggest auction of index-linked sovereign debt in UK history, a massive dispute broke out, with investors publicly accusing the authorities of bad faith after the Bank hinted, just 20 minutes after the sale had closed, that it may soon stop buying gilts.
Such a row is almost unprecedented. It is of huge and pressing importance to this country’s future status as a viable going concern. Yet it barely registered on the media’s radar, receiving a mere fraction of the column inches devoted to the soap opera of Norwich North
QE EXIT WILL BE YANKED FROM AMERICAN HANDS
Last week, Federal Reserve Chairman Ben Bernanke spent two days testifying before Congress. He sketched out the Fed’s “exit strategy” from quantitative easing, given growing fears among holders of US government debt. That sounds complex but is actually pretty simple – and of huge geo-strategic importance.
In a bid to recapitalise America’s failing banks, US authorities have doubled America’s base money supply in recent months, while issuing ever more “Treasuries” (or government IOUs).
Many holders of that dollar-denominated debt, the vast majority of which isn’t indexed-linked to inflation, are worried they’ll lose out as America’s super-loose fiscal and monetary policy causes an inflationary surge and a much weaker dollar.
If that view crystallises among investors, they’ll stop buying US Treasuries, or buy far fewer, at a time when America desperately needs cash. The world’s biggest economy would then visibly struggle to “roll-over” its debts - sending financial and political shockwaves across the world.
So, America’s “QE exit strategy” is far more than a debating point among nerdy economists. Can the Fed get the inflationary toothpaste back in the tube?
Bernanke claims America’s monetary expansion can eventually be mopped up by raising the interest on commercial bank reserves held by the Fed – encouraging banks to keep more money out of circulation.
That’s politically painful, not least because the interest paid on such reserves sets a floor for the Fed funds rate. In other words, borrowing costs would be pushed up across the economy, further squeezing debt-soaked firms and consumers. But, just as in the UK, the US authorities may have to raise rates because their creditors force them to do so.
While some Congressman blasted Bernanke, his own government and Wall Street back the Fed’s wildly expansionary policies. Myopic politicians and desperate investment bankers care little about medium-term inflation and the fleecing of taxpayers generations hence.
American officialdom will have a much harder time this week when they try explaining the Fed’s “QE exit strategy” to the audience that really matters – the Chinese government. Tomorrow and Tuesday, Vice Premier Wang Qishan is visiting Washington to issue a warning that US monetary and fiscal policy should be “more responsible”.
While Bernanke got through his Congressional testimony without giving a timeframe for implementing the post-QE pain, the Chinese will be pushing for answers – which, behind closed doors, America could be forced to give. After all, around half of all publicly-held US debt is now held by foreigners – and China is the biggest creditor by far.
America used to defend its enormous national debt by arguing the country owed the money to itself. That’s no longer true. And the fact it isn’t means America’s crucial QE exit strategy could soon be yanked from American hands.
Liam Halligan is Chief Economist at Prosperity Capital Management