UK needs to swallow the bitter pill of reality

Millions of ordinary Britons are worried sick about debt and falling incomes. Unemployment and house repossessions are soaring – glib statistics which mask a welter of human misery. Countless UK firms are struggling with cash flow as they try to balance the books. And we’re all sick of the grim economic news.

No wonder the UK’s “imminent recovery” is getting a lot of coverage. Last week, I returned from holidays abroad to find our media banging the “recession is over” drum. In truth, though, the UK remains in economic dire straits.

I write this not to “talk down the economy” – although I’ll be accused of doing so. I’m countering the prevailing “consensus” as that’s what the evidence suggests. I’m also concerned that by insisting everything is rosy, a vast panoply of political and financial vested interests can claim their counter-productive “rescue measures” are working, while avoiding the tough regulatory changes we need to prevent “sub-prime” happening again.

A series of self-serving “surveys” has fuelled the “imminent recovery” myth. Based on such hype, and a tidal wave of government largesse, UK shares have surged 15pc over the last two months.

The City was euphoric last week after it emerged that rather than contracting 0.8pc quarter-on-quarter during the second three months of this year, UK GDP fell only 0.7pc. News of this “rebound” was screamed from the roof tops. Less was made of the far more informative year-on-year data showing the economy shrinking by 5.5pc – our worst ever peace-time performance.

Coverage of the actual economic data is being overshadowed by the “results” of heavily promoted surveys from estate agents and stock brokers pointing to “rising house prices” and “growing confidence”.

The genuine numbers, alas, show that firms slashed investment by a staggering 10.4pc during the second quarter of this year, more than the 7.6pc cut during the previous three months.

Business capital spending – the lifeblood of future growth – is now falling at its fastest rate in more than 50 years. Less investment not only suggests more limited future capacity, but lower productivity too – seriously undermining the UK’s medium-term growth trajectory.

Combine that with impending tax rises and the reality that we’ll be spending ever more of our national income on unproductive debt-service and it’s hard to see how the UK can avoid a prolonged “bath-shaped” recession.

The most important piece of data published last week concerned our still deeply dysfunctional credit markets – yet it generated little comment. British banks claim “lending is up” but that’s untrue. Billions of pounds of taxpayers’ money is being “lent” by banks to their off-balance sheet vehicles - in a desperate attempt to wipe out the sub-prime toxic waste said banks so stupidly took on. But that’s not “lending” as far as UK firms and households are concerned.

Net lending to non-financial UK companies fell £4.1bn in July, the steepest decline since the credit crunch began. Despite the bank bail-outs, firms remain desperately short of the working capital that makes commerce possible.

Credit-starved businesses will be forced to make even more lay-offs in the months to come – particularly the UK’s smaller firms, which employ millions of people but are finding it almost impossible to access finance. Rising unemployment will push up default rates, not least as interest rates rise, threatening renewed financial turbulence as more mortgage-backed securities go wrong.

The credit crunch has hit the UK extremely hard. Our households are more indebted and our reliance on financial services is greater than any other Western economy. Last week, the International Monetary Fund concluded the UK will suffer a sharper decline in its potential growth rate then the Eurozone, the US and Japan as a result of this crisis. Given our previous dependence on credit-driven growth, that’s hardly surprising.

I worry, though, that while the UK is already destined to be among the very biggest crunch victims, our so-called leaders continue to foist a policy cocktail upon us that’s making our predicament even worse.

Yes – other nations have implemented a fiscal boost. But the UK’s finances were in an awful state going into this crisis and we’re now borrowing at a faster rate than any other major economy.

Yes – quantitative easing has been used elsewhere. But the UK has been uniquely profligate in spending almost all the newly-created “funny money” on government debt, rather than corporate instruments. Our central bank has bought a far higher share of all gilts issued over the last six months than any other Western country – making us uniquely vulnerable not only to a gilts strike, but also a potentially devastating currency collapse.

“Imminent recovery” is easy to swallow. The bitter pill of reality gets stuck in the throat. The UK needs to swallow hard and face the truth, ending the damaging “stop gap” measures that risk wrecking what’s left of our economic future.

BERNANKE REAPPOINTMENT SHOWS HOW LITTLE WE'VE LEARNT

Last week, Barack Obama nominated Ben Bernanke for another four-year term. The Chairman of the US Federal Reserve was lauded by the President for the “temperament, courage and creativity” he has shown steering America through “one of the worst financial crises in history”.

I’m aghast by the lack of protest at this proposed re-appointment. The near-universal praise for Bernanke shows how little we’ve learnt from this credit crunch and how easily such a fiasco could happen again.

There’s a grave danger Bernanke’s “solution” to the crisis – rampant money-printing and ultra-low interest rates – could yet result in a dollar crisis, soaring inflation and the end of America’s financial hegemony. I don’t want to see that happen, but I think it could.

Bernanke will remain the world’s most important policymaker even though his pre-crisis actions contributed mightily to the financial meltdown. A former academic at the heart of the US establishment for years, he was Chairman of the President’s Council of Economic Advisers before taking over from Alan Greenspan at the Fed.

After the equity bubble burst in 2000, Bernanke provided Greenspan with the intellectual cover to keep rates too low for far too long – sowing the seeds of the sub-prime collapse. When, in 2004, Greenspan claimed “our strategy of addressing the bubble’s consequences, rather than the bubble itself has been successful,” he could only do so with Bernanke’s “expert” endorsement. Yet Greenspan’s statement will surely go down as one of the most misguided in financial history.

When warnings were issued about lax regulation, bank over-stretch and flagrant mortgage abuses, Bernanke not only ignored them but spouted reasons why such warnings were wrong. When we were borrowing like crazy, building up massive “global imbalances”, it was Bernanke who blamed not the West for saving too little, but Asia for saving too much.

Throughout his career, Bernanke has danced to Wall Street’s tune. No wonder the money-men are delighted he’s staying put. Congress has yet to confirm the appointment, but it will – once his critics have been bought off with yet more borrowed money.

America will eventually beat this crisis and emerge as an economic powerhouse once more. Politicians and policy-makers will rush to claim credit. But the US recovery, when it comes, will be driven by the grit, talent and hard work of ordinary American people. It will happen in spite of, not because of, the actions of Bernanke and his ilk.

Liam Halligan is Chief Economist at Prosperity Capital Management