It is a year since the credit crunch reverberated round the world and it has taken all of that time before the impact has really hit the real economy. True, the housing market in most developed nations was hit earlier. Here in the UK the peak in prices was last October/November. But that is somewhat different: in the US the peak in prices came towards the end of 2006, so it preceded the crunch and in some measure was the trigger for it.
If you look at the real economy, as opposed to asset prices, it is only now that negative growth numbers are starting to come through. Denmark has the dubious distinction of being the first developed country to move into recession and the latest figures from Germany suggest that the economy may have declined in the second quarter. It is possible that the eurozone economy as a whole will have contracted during the quarter. The US, on the other hand, has continued to grow during that period, thanks in part to a fiscal boost but also the astounding resilience of American consumers.
And here? Well, let's focus on the UK because the British economy is at a most interesting stage – interesting in a slightly ghoulish way. It looks, from the National Institute of Economic and Social Research monthly estimates of GDP, that the economy is still growing, with an estimate of 0.1 per cent growth in the three months to July. The International Monetary Fund's latest forecast, just out, has growth this year at 1.4 per cent and 1.1 per cent next – with a 15 per cent fall in house prices pencilled in. Several commentators reacted to these two bits of information negatively: very slow growth now and a forecast below the bottom of the Treasury's range for this year.
That seems to me to be a "bottle half-empty" reaction. Given the huge hit the economy has taken from higher fuel prices and the collapse in housing sales I think it is impressive that it is growing at all, particularly if Germany, which most of us thought was well-placed, is shrinking. As for the IMF forecast, that is now pretty much the consensus but I find the "better than expected this year, but worse next" view more convincing. Capital Economics has 1.7 per cent growth this year but only 0.5 per cent next and that feels about right. But that profile would still be consistent with a technical recession (defined as two successive quarters of negative growth). You can have two quarters when the economy shrinks yet still have some growth over the calendar year. How you react to that is a classic half-full/half-empty dilemma.
The R-word has such resonance and is bound to send a shiver through people's spines. Memories of the early 1990s linger and they were not much fun. But have a look at the top graph. That shows the Capital Economics forecast together with the record since 1970. The top line, growth, dipped below the zero point in the 1970s, 1980s and 1990s, for there were full calendar years when growth was negative. This time it is predicted to dip but not go below the base. Now it may be worse than that but it is worth repeating the point that, as yet, I can find no mainstream forecaster who predicts an annual contraction for the economy for 2009 or 2010. The housing market may be as bad as the early 1990s, and it is looking more and more as though it will be, but the economy as a whole should do better.
Why? Well, one reason is that it should be possible to boost the economy through a fall in sterling and lower interest rates, neither of which were possible when sterling was a member of the ERM. The first has already happened. And the second? We won't get a fall in rates from the Bank of England today – I would be amazed if there were any change – and the peak in inflation is still some way off. But, looking ahead, it is plausible that rates could be on their way down maybe even as early as October.
The second graph explains why. It shows some predictions from Goldman Sachs of the Consumer Price Index and the core CPI, taking out food and fuel, through next year. The core has remained under good control and the headline figure is set to fall. You might say that the core concept is a bit absurd; after all food and fuel are the two things you have to buy, whereas you can always put off buying a new suit or a new TV for a few months. Even so, once a turn is in sight the way would be clear for an interest rate decline. At the moment commodity prices are falling faster than at any time for two decades.
The question then becomes, even if official rates come down, will money market rates follow? The gap with money market rates, the three-month London InterBank Offered Rate (Libor), has remained stubbornly high. That is a key measure of stress in the markets. Worse, many banks can't borrow at that and are having to offer even higher rates for large deposits. There are household names that are desperate for cash, as you can see from the rates they advertise.
Here it is less easy to be optimistic. When the credit crunch struck, most of us thought that it would be several months before things returned to normal but I don't think any of us believed it could last a year. We were wrong: there is as yet no end in sight. While markets remain stressed it does not help much if the central bank cuts the rates. Look at the US: Fed rates are 2 per cent but house prices are still plunging. The measures the Treasury is working on here, including a stamp duty holiday and maybe more local authority mortgages, will have only a marginal impact. The value of our housing stock is falling at an annual rate of about £400bn – a billion pounds a day; £5bn or even £10bn of additional public borrowing is not going to change much. Indeed, more public borrowing may just scoop up more of the pool of available savings and so reduce the amount that banks can lend. Think about it. A depositor has £100,000 to place. He or she can put it into a bank or buy the new and attractive gilt issued by the Government. So if the Government borrows more, the bank may lose deposits. Result? Little or no net boost to the economy.
Besides, the leeway for the Government to increase its borrowings is very limited, even if it were going to be effective. Goldman Sachs reckons borrowings this year could reach £50bn, which is troubling but I think next year looks the really alarming one. We may have a new Chancellor by then but of course it is not Mr Darling's fault. Taxes, as you can see from the final chart, are not much higher as a percentage of GDP than they were in 2000. What has gone wrong is the surge in unfunded public spending, rising by four or five percentage points of GDP. That happened under Gordon Brown.
So the Government cannot help much and the Bank, only a little. That means we are pretty much on our own. But fortunately economies are self-healing. They adjust. We are now adjusting to higher energy prices by driving less. Companies are adjusting by switching their product mix and trimming costs. The "half-full" view of the world is to recognise that the more swiftly we adapt the more swiftly we can return to decent growth. But don't expect that before 2010 at the earliest.Reuse content