It is probably mostly the international situation, but people are heading off on holiday in a scratchy mood. It is hard to put a finger on it, but I think there is a sense that asset values pretty much everywhere are inflated, that the global recovery is uneven, and that having had a first half of strong economic performance here in Britain, maybe the second half won’t be quite so positive. That leads into the timing and slope of the return to normal interest rates, with the first increase in base rate in November now in the markets.
Of course you have to make a distinction between the markets and the economy, and there is still quite a bit of slack in the latter to make up. But the more mature this expansion becomes the more people will start to ponder how long it can last. There is such a thing as the economic cycle. So it might be helpful to take a look forward; to think about the nature of this cycle, and how it might develop.
Obviously if you start a cycle from a long way down, you are likely to be able to grow for longer, for you are simply taking up spare capacity. You can catch a feeling for that in the top graph (below), which shows what happened to growth during the recession and recovery for the UK, US and eurozone. It also shows Goldman Sachs projections through to 2018. The UK numbers will probably be revised up when the national accounts are reformed in the autumn. There will be an increase because of new ways of calculating the statistics and that will be around 4.5 per cent – in other words the economy will appear larger simply because the figures are calculated in a different way to bring us in line with the rest of Europe. But quite separate from that, there are likely to be revisions of real output, which will show that growth in the last couple of years has been stronger than initially thought.
But now look forward. Forecasters have to be brave, but isn’t the flat outlook for all three regions rather questionable, given the huge fluctuations in the past? Are the UK and US really likely to grow at around 3 per cent a year, and Europe at 1.5 per cent, right through to 2018?
I ask the question because economic cycles seem to come at seven- to ten-year intervals. We had a recession in the middle 1970s, the early 1980s, the early 1990s, and of course in 2008/9. The missing one was 2000/1, when the dot-com bubble deflated, which did lead to a very minor downturn in the US, but from which the UK largely escaped. The next escapade however made up for that, and those of us who thought that the amplitude of the cycles was diminishing were proved spectacularly wrong.
So the questions are: when is the next downturn likely to occur and how serious will it be?
If the seven- to ten-year cycle holds we should expect the next downturn to come in 2017/8 at the latest. A common-sense guess would be that the interval will be quite long simply because the previous downswing was so vicious, but on the same basis does this also imply that the next downturn will not be very serious?
Well, I don’t think we need fear another 2008/9. That is not just because in the past that degree of wealth destruction has only come every 70 years or so. It is because lessons have been learnt. We now have a much safer banking system, arguably too safe a system in that we have one that is reluctant to lend on any project deemed risky.
You can catch some feeling for the impact of this reluctance on the economies of the US, UK and Europe from the bottom graph: the surge in unemployment that took place after 2007. The US and UK have managed to get unemployment back to more acceptable levels but they are not yet back to pre-crisis. The forward projections don’t even bring unemployment down to the level of 2005. As for Europe, it is a catastrophe. If Goldman Sachs is right, eurozone unemployment will remain above 10 per cent right through to 2018. The eurozone encompasses countries that have a very different performance but the thought of going into the next downturn with unemployment still in double digits is frightening indeed. There may be no recession in 2018, but you cannot be confident of that. Italy is back in recession now, something that was not at all predicted by mainstream economists.
The scale of the next dip? There has been some work by Simon Ward, of Henderson, looking at the different economic cycles and how they interact. Cycle theory is one of those once ground-breaking, now unfashionable, areas of economics that was made famous by the Austrian economist Joseph Schumpeter in his book Business Cycles, published in 1939. He pulled together the long-waves first noted by Nikolai Kondratieff, the familiar seven-to-ten year cycle of Clément Juglar and the short three-year cycle of Joseph Kitchin, one driven by inventories. Later work was done by Simon Kuznets, who identified a 20-year cycle.
The point about all this is that when cycles coincide, so Simon Ward argues, you are likely to experience greater amplitude. The Kuznets, Juglar, and Kitchin cycles all came together in 2008, a rare occurrence leading to that disaster.
If you are interested in this work, there is a lot of good stuff on the web. The whole idea of fixed cycles has been much criticised, but the fact there is some sort of cycle is openly acknowledged. Remember that Gordon Brown promised to balance the books over the economic cycle, only to change the assumed dates of the cycle when they didn’t balance.
At any rate the point here is that the next downturn will see the bottom of a Juglar cycle coinciding with a fall in the stocks cycle of Kitchin – but the good news is that the Kuznets cycle is still going through an upswing.
Don’t let any of this spoil the holidays. But do be aware that there is likely to be another downturn, probably a mild one, in another three or four years’ time.