Karen Ward: So just who will be the winners and losers from the housing crash?

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The Independent Online

In the classic 1980s film Trading Places, two of the world's most important businessmen find themselves on opposite ends of the nature versus nurture debate. In order to settle a one dollar bet, they put one rich stockbroker on the street and promote a homeless man into his position. The aim is to see if the beggar can thrive from such lowly roots and the well-bred stockbroker recover his fortune.

A nature versus nurture experiment is also under way at two of the world's most powerful central banks. Ben Bernanke, the chairman of the United States Federal Reserve, firmly believes in the need for nurture. He has slashed interest rates in the US over the past year, while his counterparts at the US Treasury have joined in by pumping out tax rebates in an attempt to help the flailing US economy.

At the Bank of England, meanwhile, the Governor, Mervyn King, appears to have placed his faith in nature. Last week, the Bank's Monetary Policy Committee kept interest rates on hold. And when King unveils the committee's latest assessment of the economy in the quarterly Inflation Report on Wednesday, he is likely to stress that rate cuts remain firmly off the agenda.

Despite their radically different approaches, both Bernanke and King still seem to expect a similar outcome for their respective economies. Sure, a period of lacklustre growth may be in prospect. But their best guess is that, before too long, this will be followed by a perky rebound in activity. Indeed, in the last Inflation Report, the Bank of England forecast that by the end of next year, the UK should be cruising along at a similar pace to that seen during the golden years of the past decade.

All of which presents something of a puzzle. What makes the Bank of England, unlike the Federal Reserve, believe that its economy can navigate its own way back to the path of economic recovery?

A key difference between the Bank's and Fed's views relates to the impact of falling house prices. A long-standing belief at the Bank of England has been that a collapsing housing market won't necessarily spill over into the real economy. The argument goes that those planning to trade down may lose out as house prices tumble. But those trading up in the future gain. Like in the movie, they're simply trading places.

This argument provides an intellectual slap in the face to those doom-mongers who proclaim that housing market meltdown spells Armageddon for the wider UK economy. But there's just one problem. The reality isn't quite as straightforward as the theory might suggest.

In practice, the behaviour of housing market winners is not a mirror image of the behaviour of housing market losers. For a start, some of the main beneficiaries of lower house prices haven't yet been born! And, for the rest of us, our response to housing market developments will depend on key characteristics – such as age.

For example, my eight-year-old nephew, with a lifetime ahead of him, didn't respond to booming house prices by saving his pocket money in anticipation of the larger mortgage payments he would face in later life.

Now house prices are falling, he hasn't suddenly taken out a bank loan and forked out on more sweets and video games than are healthy.

By contrast, my grandparents' home is their pension fund, to draw on in their final years. As its value rose sharply, they thought they had more money to play with over their retirement and their spending adjusted accordingly. As house prices decline, they are reassessing and tightening the purse-strings.

But the biggest reason to be fearful of wretched housing market conditions is that they may be telling us something about people's concerns for the future. When consumers anticipate bad times ahead – perhaps because of a concern that higher energy prices have hit their spending power and will continue to do so – they are less likely to splash out in the housing market. Before too long, their spending on goods and services will take a hit too.

In short, without some tender loving care, it's hard to see consumer spending providing much if any impetus to the envisaged recovery.



The second reason the Bank of England is confident that the UK economy can stand on its own two feet relates to other "trading places" – our overseas markets. The depreciation of the beleaguered pound, by some 13 per cent in the past year, should encourage other countries to buy up our goods and services. In fact, Charlie Bean, the Deputy Governor, argued that the decline in sterling could do the work of 3 percentage points worth of interest rate cuts.

The implication is that by exporting our troubles away, the economy will rebalance, rather than grind to a painful halt. The US experience shows that this can happen. In the second quarter alone, US exports rose by almost 2.5 per cent and was the lynchpin of overall growth.

But, of course, the Bank of England has followed a very different path to the Federal Reserve. More aggressive interest rate cuts in the US have encouraged a more aggressive decline in the dollar, which is down 35 per cent from peak to trough. The fall in sterling, while still substantial, pales in comparison.

The UK's pattern of trade is also differs from the US. One consequence of looser interest rate policy in the States has been looser policy for those countries pegged to the dollar. So, far from catching a cold as the US sneezed, the emerging markets went to the races. But whereas China ranks as the third largest destination for US exports, it is far less important for UK exporters. In fact, only 3 per cent of UK exports go to the key emerging economies of China, India and Russia.

Instead, the UK is far more dependent on the eurozone, which accounts for about half of our exports. Growth there held up at the beginning of the year. Since then, its economy seems to have floundered. Indeed, a leaked report last week suggested that the German economy, the engine of eurozone growth, contracted by a full 1 per cent between April and June.

The bottom line is that the promise of an export-led recovery is increasingly looking like the triumph of hope over reality. Given the dire outlook for inflation over the next few months, it's probably not in Governor King's nature to nurture the UK economy quickly back to health. That would require the kind of stimulants that would make an Olympian blush, let alone a conservative central banker. But without a sizeable injection of interest rate cuts, the UK economy looks set to stay in the doldrums for some time.

Karen Ward is UK economist at HSBC; Stephen King is away

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