Hamish McRae: The gloom is overdone but this is a blow to the recovery
It is important to balance scepticism with a realism that this is disappointing
Thursday 26 January 2012
So it is perfectly plausible that, on the official figures, the UK is indeed heading for a double dip. However you try to explain the figures, this is disappointing. Even if they are understating the level of economic activity, which I think they are, it is still disappointing. And it does not matter whether the economy technically goes into recession, as defined by two successive quarters of negative growth, for very slow growth such as we are having makes cutting the deficit even harder.
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Still, there is a puzzle. According to these figures the economy shrank in the final quarter. Yet tax revenues were quite strong and consumption was up a little. As a result the deficit-reduction programme is still on track. As a number of commentators including Goldman Sachs have noted, there is a consistent downward bias in the initial estimates of UK GDP going back 30 years. We have recently been told that the peak in output at the top of the last boom was higher than previously estimated. In the early stages of the 1980s and 1990s recoveries the initial estimates of GDP understated activity by 0.35 per cent a quarter. So it is quite possible that, far from shrinking, the economy actually grew a little in the final quarter of last year.
But it will not have grown much and it is important to balance a scepticism about the figures with a realism that this is a slow and disappointing recovery. The first chart, taken from the National Institute, shows its estimate of the present recovery compared with those of the 1930s, 1970s, 1980s and 1990s. As you can see we have now dropped below the profile even of the 1930s. Those of us who expected that we would follow pretty much the trajectory of the 1980s recovery have been proved wrong.
The natural reaction to this is to blame someone: the Government, its predecessor, the bankers, the central bankers, the eurozone leaders, whatever. But this helps not at all. As it has turned out, as far as the deficit-reduction programme is concerned, the policies of this Government are remarkably similar to those set out by Labour. Fraser Nelson pointed this out in The Spectator and the second graph demonstrates this similarity. It is true that originally George Osborne planned to trim the deficit a little faster than Alistair Darling but has had to slow down a bit. But it has to be done and I suspect that any government of any political colour would have followed pretty much the same course. The national debt, now more than £1,000bn, goes on rising for several years yet.
So what happens next? If you have a huge boom fuelled by credit it will inevitably take several years to grind away at that debt, even with artificially low interest rates, even with quite a bit of inflation, and even with part of that debt being monetised by the Bank of England – printing the money to cover the deficit. Sir Mervyn King made a thoughtful speech on Tuesday, noting that this process of deleveraging had begun, with households being net savers for the past three years. Those days of equity take-out, when people increased their mortgages to pay for consumption, are long past. But we have as individuals, as well as a country, a long way to go. The first response of the markets to the Governor's speech was that this confirmed that the Bank would have another bout of quantitative easing next month but this reading was tempered by the minutes of the Monetary Policy Committee, which suggested some members were more cautious. At some stage the QE programme has to end and the massive stock of debt on the Bank's books has to be unloaded on to willing long-term buyers. The total debt held by the Bank is £263bn and it has authority to buy £275bn. So it cannot do much more without a further agreement, which may indeed come. But since the Bank now holds more than a quarter of the entire national debt, you do have to wonder whether it buying yet more would really have much impact on demand. The monetary accelerator is already on the floor.
Nothing in financial markets is forever. The present benign mood towards British government debt, as evidenced by strong demand yesterday for some gilts maturing in 2052, yes 2052, will not last. The trouble is that none of us knows when that turning point will be. For the moment our AAA status seems secure, rather surprisingly perhaps. But more and more you hear people questioning whether it can really be sensible to lend to a government, any government, for 30, or indeed 40, years at 3 per cent. The long-term bear market in prime fixed-interest securities has not yet begun but somewhere there is a turning point. The more artificial the circumstances in the run-up to that turning point the more violent the reaction is likely to be.
There is, I suppose, a danger that a long period of slow growth might undermine the UK's credit rating. Were the debt-to-GDP ratio to reach 90 per cent, not impossible, our relative attractiveness would be damaged. But we are not yet in the position of Italy, or even France. As long as we do not take for granted our ability to borrow at very keen rates we should be able to do so. A more general problem would be a wider retreat from holding sovereign debt. But were that to happen – small comfort – there are a lot of other countries in a worse plight than we are.
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