The economic world changes by the day, with increasingly discouraging economic news met by increasingly vigorous – you could almost say desperate – action by the authorities to counter it. It is a bit bewildering for all of us so perhaps the most helpful thing to do is to stand back and review where we are now.
What seems to have happened is what might be called the "Wyle E Coyote effect". You know how the cartoon character is chasing the Roadrunner, runs over a cliff and goes on running in mid-air. Then he looks down, realises there is no ground underneath and only at that point does he plunge to the ground.
The world economy was running along pretty strongly until July, and though things got a bit wobbly in August and September it did not fall off a cliff. The sudden sharp downturn in the real economy right around the world came during the second half of October. It happened here but it also happened in the US, across Europe, China and India and in the other emerging economies.
The trigger seems to have been the collapse of Lehman Brothers, which led to a collapse of confidence in the global banking system around 7 October, which then moved on to the real economy. The data calibrating the fallout is now coming through.
There was, for example, a new set of revisions from the International Monetary Fund for growth next year. These were the ones that suggested UK growth (or rather lack of growth) would be the worst of the major economies, with a minus 1.3 per cent pencilled in for 2009. IMF chief economist Olivier Blanchard said: "We think that global fiscal expansion is very much needed at this point. If it comes, then the forecast we have will be on the pessimistic side." There were very poor industrial production figures from Germany and dreadful employment numbers from the US. And yet to be revealed, there was doubtless some very disturbing UK economic news that provoked the Bank of England into that unexpected and unprecedented one-and-a-half point cut in official interest rates.
What seems to have happened was that the Bank received a devastatingly bleak report from its agents around the country, whose job it is to report back on what is happening to local businesses. Their earlier reports (see graph) show a steady deterioration in recent months but when the latest reports are revealed I expect the results will be much worse still.
And so the Bank's monetary committee cut rates. There is now a general view that rates in the UK will come down further, quite possibly to the 1 per cent level they are in the US by the middle of next year. But before home buyers should allow themselves to become too cheerful about this they need to recall three things.
One is that very low rates in the US have not revived the economy there, nor did they do much to help the Japanese economy escape from stagnation during the 1990s. A second is that there is a huge gap between official rates and the rates at which the banks can borrow from each other, the wholesale money market rate, even if these markets were open and they are still pretty much shut. And third, insofar as rates for savers will come down too, there will be losers as well as gainers. There are about four times as many people in Britain who have interest-bearing deposits as those who have loans, so numerically more people lose from a fall in rates than gain.
But, basically what has happened in the past few days is that the outlook has got much worse and the prospects for inflation have got much better. So interest rates will go on falling. That leads to two more questions. One is just how much should we re-calibrate our expectations for the global economy, and, in particular, our own? The other is what might a world of very low official interest rates (but very high budget deficits) feel like?
Well, you have to take seriously the downward revisions from forecasters such as the IMF, and this week we will get confirmation that the Eurozone is already in recession, having had two successive quarters where the economy shrank. The big graph shows how the forthcoming downturn might compare with the early 1990s. This projection comes from Capital Economics, which has been very good at picking up the deteriorating outlook, but I should point out that it is now quite a lot more pessimistic than the consensus in that it does not expect a recovery in 2010.
If it is right, this downturn will be worse for the UK than that of the early 1990s, though not as bad as the 1970s and 1980s. Most mainstream forecasters still think that this will not be as bad as the early 1990s, at least for the UK, and that is still my inclination, but we will have to see what the Treasury says in its forecast in the pre-Budget report, due later this month.
That will be the next focal point for economic management. The budget numbers will be dreadful, with the deficit next financial year (i.e. the one that starts in April) projected at anything up to £100bn. We will have a government that is raising only about £8 for every £10 it spends and that is scary because it transfers the burden to future generations. The young ought to be very hostile to large budget deficits, for they have a profound self-interest in fiscal responsibility.
What we will have to get used to is something much more like Japan in the 1990s, or even Britain in the 1950s. Official interest rates will be low but access to credit will be restricted and prices may well fall for a period. So people and companies with cash will be in a strong position vis-à-vis those without. They will obviously be able to buy good assets from distressed sellers but I think there will be a more subtle change than that in that anyone with cash will be hunting for opportunities that offer a better return than that available from the bank or the Government. But business opportunities will be limited by the general deflation.
This will feel quite sombre. House prices now seem set to decline through 2010, only starting to recover in 2011 or maybe even 2012. That will further depress things. And as growth gradually resumes, much of it will be absorbed by the Government as it tries to curb its deficit and move back towards balance or eventually some sort of surplus. The combination of the Brown spending spree and the collapse in tax revenues will hang over the country for the best part of a decade. To be realistic, we have to accept that UK living standards will not rise much for perhaps five years.
Britain will not be alone in this. All developed countries will face a long adjustment, with governments struggling to bring deficits down and hoping that very low interest rates will boost the economy. They will to some extent, but not by as much as you might expect, particularly while house prices keep falling. Growth could resume in 2010 but it will be lacklustre until the housing market turns the corner.The world waits to see if China's citizens can take up the economic slack
The "off a cliff" October has made a lot of us start to question the belief that the emerging economies, and in particular China, would be able to maintain global demand even though the developed world failed to do so.
This year China will be by far the largest single supplier of additional demand to the world economy, much larger than the US or Europe, and that looks like being true next year too. But you have to have some doubts.
Some data sent by a friend in Beijing is somewhat troubling. Thus in September industrial production was only just up year on year, and employment in the huge textile industry was actually down. Electricity output is still up, but only by 5 per cent; all three big steelmakers are cutting production; car production is flat year on year; shipping rates have plunged; and disposable income per head is rising by only about 6 per cent, against more than 10 per cent in recent years.
Put all this together and the forecast for growth for the first half of next year from the economic consultants CEBM is now only 7.2 per cent annual rate. The "only" sounds a little odd to countries facing zero growth but the main point stands that China is slowing sharply and will continue to do so. The commodity markets confirm this. China exports 22 per cent of its output, double the rate of five years ago, so any slowdown must affect it.
What we don't know is China's ability to offset falling export demand by increasing domestic demand. In the long term that has to happen because the world is not big enough to carry on taking Chinese exports at such a rate. But the transition will be very difficult: dropping from 12 per cent growth to 7 per cent is as tricky as coming from 3 per cent to zero, the transition we are making.
How successful will the authorities be in supporting growth? Past experience suggests they will succeed. But the next few months will be bumpy in China: as big a dip in growth as after the Asian financial crisis of 1997 seems on the cards.Reuse content