Hamish McRae: Talk of green shoots in the economy is silly, but not in the financial world
Friday 16 January 2009
"Green shoots"... argh. There is always a problem for ministers when they opine on the state of the economy in tough times. Norman Lamont famously got it in the neck for using that expression to suggest that a recovery from the early 1990s recession had begun when that was still a few months away. Conversely, Alistair Darling was criticised for saying that this was the worst economic situation for half a century, or words to that effect, when all his forecasts suggested this would be a relatively mild downturn by post-war standards and all his sums are done on that basis.
But it is worth taking Shriti Vadera's use of this phrase as a text for at least three reasons. One is that all recessions appear achingly long at the time and we are liable to miss genuine signals of recovery. A second is that it focuses attention on how the adjustment process works – the various things that need to come together before a recovery can begin. And third, it puts this cycle into the context of previous cycles, making us consider whether this one is indeed still within the design limits of previous ones (as I think is overwhelmingly probable) or whether we are confronted by something quite different.
On the first, well, it is surely far too early to be talking of green shoots as far as the economy is concerned, so in that sense Lady Vadera's comment is a bit silly. What I think one can say is that the world financial system has been stabilised by the huge refinancing operation by governments around the world. You can calibrate that. One measure would be the spreads between the interbank interest rates and the central bank rates, which are still elevated but not nearly as wide as they were last autumn. Other measures are the financial conditions index and the financial distress indices created by Goldman Sachs, both of which are much lower than they were in October.
This does not mean that the world banking problem is fixed; witness the continuing travails of Citigroup, which have spooked the market for banking shares worldwide. Nor does it mean that lending levels are anywhere back to normal, wherever normal might be. Here in the UK we still have a particular problem financing the mortgage market because there are not enough savings in the country to do so. We were able to support higher levels of lending by importing funds from abroad, either with foreign institutions lending directly or by selling mortgage-backed securities to institutions in other countries. Now both those avenues are closed. We also have a problem in corporate finance, hence the discussions this week. And, viewed globally, there are massive problems in trade finance, the condition of many emerging economies, even the financial position of many successful economies, including Ireland.
Nevertheless, the acute phase of the banking crisis is surely over, so while "green shoots" is the wrong expression, one of the conditions for a resumption of growth, a functioning world financial system, is beginning to take shape. There will, in the months ahead, need to be many more preconditions for growth to be established before growth actually materialises but, by the end of this year, more of these should be coming through.
That leads to the second point, the preconditions for growth. Banks that function are one. Very low interest rates are another, and those too are now being delivered worldwide. We have them here, the US has had them for some time and Europe is now getting them too. I would add stability in asset prices, and that is not yet in sight.
We are, however, getting there. Without trying to predict what will happen to share prices, a total mug's game, it is plain that equity prices worldwide are not grossly over-valued. On some measures they are significantly undervalued, which does not mean that they won't become even more undervalued, but which does give some confidence that they will not be a new source of instability. A lot of the bad news is in the market.
There are still serious worries about property prices, however, both commercial and residential. The markets are all different and there is gross oversupply in many of them. But if you come right back to home and look at the UK housing market, you could say that something like half the adjustment has already taken place and that the falls that have happened are starting to suck buyers back in. You can see how the rise in new buyer enquires might lead a housing recovery in the first chart, compiled by Capital Economics, so maybe there is a genuine green shoot there. If this housing downturn follows the pattern of previous ones, we could be back to stable prices, at least in money terms if not real ones, by the end of 2010, maybe even a bit earlier. An economic recovery can precede a housing recovery. In fact, you would expect it to do so.
That leads into the "is this cycle normal or abnormal?" debate. Some things are certainly abnormal. The banking stress is abnormal in the sense that it is global, whereas previous banking crashes have been national. The collapse of consumption in the US is abnormal. That is really off-a-cliff, Wyle E Coyote-style stuff. It has not happened in the UK in quite the same way, however, for though sales of big-ticket items such as cars have been very hard hit, consumption as a whole is off much less and companies that can make a good purchase proposition can do very well.
The fall in sales of the big-ticket items and the investment cuts that many companies are making have, however, combined to give a huge blow to manufacturing around the world. In macro-economic terms you can see this in the plight of Germany. This wonderfully successful economy, the world's largest exporter, looks like having a more serious downturn than the UK. That is not what anyone was predicting a few months, even a few weeks, ago. At a company level it is scary because order books have suddenly dried up in a way that has not happened since the early 1990s and in some cases the early 1980s. Not many of the current crop of managers can remember that. But then this is what happens when recessions strike: a sudden adjustment as stocks build up and therefore production has to be slashed. Once stock levels are back to acceptable levels, production can resume, though maybe at a somewhat lower level than it had reached at the previous peak.
As far as the UK is concerned, it is worth trying to remember what it felt like during the early 1990s, the previous "green shoots" occasion. When we look at what happened to GDP alongside the balance of domestic sales of both goods and services as reported by the British Chamber of Commerce, we are pretty much on track for something similar to then, maybe a touch worse. Until it perks up, we cannot have any confidence that GDP will turn the corner. But the simple point is that we have been here before – though it was not much fun at that time either.
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