Tuesday, April 30, 2013

The stalled UK economy in one chart

George Osborne might have avoided Triple Dip headlines last week when the UK registered 0.3% growth, but he and everyone else knows that the economy has stalled.

Critics like the IMF and Labour point to austerity as the cause and urge him to change tack.

Others wonder why the Bank of England's monetary shock and awe, including 4 years of 0.5% interest rates and £375 bn of QE, haven't done more to create a meaningful recovery.

So why is the economy stubbornly flatlining?  Although there are a ton of possible causes from the Eurozone crisis to high oil prices, I think my little chart explains a lot.

I have plotted 13 years' worth of UK household borrowings (basically mortgages plus credit card debts) to show how quickly they rose during the Brown boom, peaked in 2008 and have wobbled around the same level ever since.

Whether you blame the government, the banks or the borrowers themselves for the reckless excesses that preceded our current recession, it was a heck of a binge.  Every year up to 2008 the private sector was borrowing around £100bn net so no wonder the economy was growing.

And it's also no surprise that it had to come to a horrible end.  House price to income ratios just got too ludicrously stretched and the debts caught up with the weaker borrowers.  So after the Brown boom, the Brown bust.

It's a familiar tale but we have seen house price-related recessions before and they end.  I am sure most people were expecting things would pick up after a couple of years as the whole cycle started again, like it did in the mid-80s and again in the early '90s.   Why not this time?

Part of the answer lies in the sheer duration and scale of the boom.  My chart shows credit expanding from 2000 but the party had got started well before.  Look at this chart of house prices:



House prices took off in the mid-90s and had already risen mightily by the turn of the century.  If we had had a recession in the early 2000s, after the dot com boom ended, then things would have turned out differently.  However the Bank of England cut interest rates and kept house prices rising to avoid a recession but at the cost of an even bigger boom and bust to come.

So that is one part of the explanation - the UK is recovering from more than your ordinary cyclical house price boom and bust.  We are struggling to emerge from a 13 year phase of two booms without a bust in between.

The other reason why bust has stubbornly failed to give way to recovery is that, in a funny way, government and Bank of England policy has been too successful since 2009.  Brown and Osborne (I think of them pretty much as one person - see Oh No! Brown and Osborne have morphed into Geordon) have both thrown everything at efforts to prevent a deflation of house prices and an unwinding of the excess debt.

In the 80s and 90s there was the pain of unemployment, repossessions, bankruptcy etc before the scene was set for recovery.  This time there has been some pain but not on a scale to clear out the effects of the boom.  Both charts, house prices and borrowings, would have to show much sharper declines to reset the economy and make a recovery feasible.

To put it bluntly the UK could, and I would argue should, have chosen to mark a clean break with the Brown boom in 2009.  This would have had involved a deeper recession for sure but at least would have cleared away the excesses of the past and set the scene for future growth.

Instead, fiscal and monetary policy aimed at making the recession as shallow and painless as possible has left  Britain unable to recover.  All the old problems - an over reliance on debt to fuel growth, outsized and inadequately capitalised banks, overstetched households, unaffordable levels of public spending - are still with us.

This explains why government policy seems so perverse at times.  Things like the diabolical Funding for Lending Scheme ("The government scheme that's crucifying savers") are desperate attempts to get back to the £100bn a year borrowing days.  And also explains why these policies will fail - people can't afford to borrow more and finance house purchases at prices which are as high as in 2008 in many areas.

Think of my chart when you listen to Osborne, the Bank of England or the Opposition.  They all chose the "shallow recession" option and should not be too surprised now that recovery seems so unattainable.


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