Hamish McRae: Growth hopes give a glimpse of light at end of the tunnel
Economic Life: An economy in which real incomes are rising will feel quite different, and that is in sight
Thursday 09 February 2012
it is funny how moods shift, isn't it? There has of course been the rise in general optimism demonstrated by the strong equity and commodity market performance pretty much everywhere – a rise notwithstanding the continuing discord in the Middle East and the rising worries about the European economy and the euro.
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Britain has seen its share prices climb along with the rest, though this is probably more a reflection of the international nature of the companies represented in the FTSE 100 index than any home-grown cheer. But in the past few days a few people have started to wonder whether we might start to see some upward revisions in growth forecasts, after a year of quite the opposite experience. This uplift in mood is fragile and it may not be enough to halt a further modest expansion of quantitative easing, which if it comes will be announced today. But it is worth a closer look.
The first point to be made is that it is perfectly possible that household disposable incomes will start to rise in the second half of this year. I had not fully realised the way household incomes were protected, even boosted, during 2009 and the early part of 2010. As the economy plunged into recession, the surge in public borrowing had the effect of pumping money not only into the economy but directly into people's bank accounts. But that obviously could not be sustained and one effect of correcting the deficit was to squeeze real incomes. These incomes were further reduced by the unexpectedly high inflation.
The result, as you can see from the first graph, was that while the change in real GDP hit bottom in 2009, the change in real household incomes hit bottom towards the end of last year. They are still negative now, but they are projected by Goldman Sachs to go positive later this year and remain decently positive through 2013 and 2014. It is true that the Goldman Sachs economists were over-optimistic about UK growth last year and their outlook now is above the consensus, but this flip from a squeeze on real incomes to a rise does seem perfectly plausible. It is going to happen in the next year or so and I suppose the main issue is how quickly inflation will fall and permit the shift to come through.
How might this affect the process of fiscal consolidation? Well, not very much. The perception of that has also shifted a bit in recent weeks, with the deficit this year now seen as coming in within the Office for Budget Responsibility's revised target, maybe a bit below it. That is mainly the result of higher-than-expected tax receipts, which may in turn reflect faster-than-recorded growth. But the picture for next year and beyond remains pretty daunting. You can catch some feeling for this from the second graph. As you can see this fiscal year shows the biggest adjustment relative to GDP as compared with future years but there are still those years ahead.
You can look at this in two ways. You can say that the squeeze becomes less marked from now on and that as a result the economic impact will be less. On the other hand you could point out that we have only done about one-fifth of the consolidation that is needed and of course the first cuts are always easier than the ones that follow.
Of course there will still be a loss of real income; of course there will be permanent damage to the economy; of course living standards will take several years before they recover. Still, an economy in which real incomes are rising will feel quite different to one where they are falling and we are in sight of that. A further final point: real incomes will be rising because of real increases in economic output, not because of an unsustainable borrowing binge at a personal and a national level.
Playing the equities long game
The Equity Gilt Study, now produced by Barclays, has just come out in its 57th edition – a continuous look at what has been happening to share and bond prices on both sides of the Atlantic, originally done by London stockbrokers de Zoete & Gorton, which became the Z of BZW when Barclays took it over and which has now become Barclays Capital.
I find it fascinating, and investors should too, because the only way to make sense of current markets is to set them in their historical perspective. We live in most unusual times, particularly as far as long-term bond yields are concerned. Try these three points.
First, over a very long period, equities give a better return than bonds or cash – something that is important to remember after the long bull market in bonds. In Britain the excess return on equities over bonds since 1900 has been 3 per cent; in the US since 1926, 4.5 per cent.
Second, the study asks whether at the moment it is bonds that are too expensive or equities too cheap. If you take price/earnings ratios as a benchmark, in the US equities are cheap only in relation to the bull market of the 1990s. They are expensive when compared with the 1970s. In Europe they are indeed cheaper on this measure, and close to the levels of the dark days of the 1970s.
Point three relates to the US, UK and Japan borrowing at very low rates, despite their national debts. Barclays comments: "institutional advantages merely buy time, and all three countries will have to take significant action to restore fiscal sustainability... or face adverse economic and market consequences." So if they are only buying time, should they be able to borrow so cheaply?
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