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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Arise Sir Mervyn! No, really, we're serious.

When I first read that Mervyn King, governor of the Bank of England, was getting a knighthood, I thought it was a joke. Like Gadaffi getting the Nobel Peace Prize or Gary Glitter being honored for his work with children. It is an extraordinary decision even allowing for the fact that any senior figure in the public sector seems to get a gong whatever their track record (how long before it’s Lord Brown of Deficitshire?). Talk about rewards for failure.

He certainly can’t have got it for doing the job he is officially charged with. According to their website, the Bank of England’s mission is:

“Setting interest rates to keep inflation low.”

Look a little lower down and you see the current stats: Bank interest rate 0.5% Inflation 4.5%. It is clear that the Bank has thrown away its mission statement and adopted a stance more like “setting interest rates ludicrously low to guarantee high inflation”. Inflation has now been above target for nearly 3 ½ years.

Pensioners, savers and charitable trusts are being mugged with negative interest rates that are quickly eroding the value of their money. Ordinary workers are getting pay rises of 0-2% and are having to cope with food and energy price rises into double figures.

The argument that inflation is down to temporary factors like high oil prices wore thin long ago. It was four years ago when Mervyn wrote this, in a letter to the Chancellor :

“an unexpectedly sharp increase in domestic energy prices” and “weather-induced” high “food prices” had pushed inflation over target, but the Bank could safely “look through the short term volatility in inflation” and was “on track to meet its target in the medium term”.

He said pretty much the same at the Mansion House this week. Four years of the same tired old excuses. If they were serious about inflation, the MPC could put up interest rates, strengthen sterling and lower imported food and energy prices at a stroke.

He has practically admitted that the inflation remit has been sacrificed but claims that the economy simply cannot stand higher interest rates. He thinks we should gladly accept an insidious transfer of wealth from savers to borrowers as the price of recovery. But how strong will that recovery be when the supposed demand boost from low rates is offset by higher prices? Retailers have been lining up to complain about the effect of high inflation (particularly petrol prices) on the spending power of their customers, and this is a direct result of the falling pound, the very thing King and the MPC have been seeking.

But my real problem with Mervyn King is not his current policy choices which are admittedly tricky given that the country is practically bust. It is the choices and miscalculations he made during the boom which preceded the recession and directly led us to this point.

He and Gordon Brown may propagate the myth that some overpaid bankers and sub prime Americans ended the apparently golden economic decade prior to 2007. But the credit crunch did no more than expose the fact that most of the economic growth during that time was illusory - built on a flood of debt and precious little else. Money supply grew by an average 11.9% p.a. between 1996 and 2007.

King was in charge during the boom but did nothing to try and calm it, despite warning signs flashing red: soaring house prices, a credit binge that saw households triple their debts to £1,500 billion, gaping balance of payments deficits, crazy bank excesses and highly leveraged takeovers.

The hangover from all this is what underlies all the economic suffering today. Why did he do nothing? He miscalculated that because retail price inflation wasn't rising too fast then everything was OK. He had his eye on one gauge of monetary health and ignored the bubbles and credit build up around him.

It's a bit like a man driving through a built up area with a dead pedestrian on the bonnet and carrying on as normal because he is travelling under 30 miles an hour: one thing is right so everything must be alright.

You might have thought that the 2008/9 recession would have caused a rethink but, apart from some scapegoating with the banks, nothing has changed. We have the same governor peddling the same low interest rate policy to encourage households to take on even more debt – the goal is £2,100 billion according to government forecasts.

The more astute readers will have spotted that my blog’s picture is not actually Sir Mervyn but his double, Benny Hill. Benny never got a knighthood but perhaps he should have – his comedy might have been bawdy and corny but at least he reliably delivered what was expected of him: laughs. King has been deputy governor or governor for 14 years now and has, by slavishly adhering to the low interest rate orthodoxy of the age, delivered an unsustainable boom, a foreseeable bust and now seemingly endless stagflation. Of course he hasn’t done it all on his own but, after honouring him for this colossal failure, the joke is on us.

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Avoid child savings account rip offs

Child savings accounts should be a rare win-win-win situation in the world of personal finance. The child gets a handy lump sum on reaching maturity perhaps to go towards Uni or a gap year. Parents and grandparents get a warm glow every time they contribute towards their loved one's nest egg. And the bank or building society gets a chance to forge a financial relationship for life.

But like most relationships, a banker's relationship with a child is open to abuse. It would appear that some of the UK's beloved financial institutions are not above picking the pockets of children just as they the adults when their backs are turned. Consider this story of the kid who entrusted £100 with tax payer owned Lloyds and got 5p interest (0.05%) in a year:

Scrooge banks rip off young savers with paltry rates

Or the Sky Blues account from Coventry Building Society that entices kids in with a link to the local football team but then offers then a miserable 0.5% annual interest. True there are better deals around, such as the Halifax Regular Saver offering 6% annually (with conditions), but these - just like adult accounts - have to be watched like hawks as the interest rate is sure to drop to nothing once the offer period is up. Indeed the Halifax account reverts to the "easy access" rate after a year, currently 0.5%

The way banks and building societies lower the rates on these accounts is particularly cynical as they know that they are the most likely to be "forgotten about". They are mostly opened with the intention of being untouched for 15 years or more and are often added to by direct debit and are rarely inspected. A perfect fleecing opportunity.

Some better alternatives than trusting the banks:

1. Getting the best rate on a children's account and then teaching your kid to check the rate every few months and move the account when the rate changes. This will educate them in the weasley ways of financial institutions.
2. Invest in shares instead. Choose a couple of high yielding blue chips like Shell and Tescos and avoid high management charges of fund managers.
3. Buy NS&I index linked bonds which guarantee to beat inflation and which do not have tax deducted
4. Invest outside the UK. Take a long term bet on an area of the world which isn't weighed down by our "rich world" problems. It's risky but maybe a long term bet on Africa or Latin America might be better than sitting on deposit and collecting below inflation returns in the UK.

From the main website: What should you do with your savings in 2011?

Resist the oily logic on interest rates

It doesn't seem so long ago that petrol was under 90 cents a litre in Spain and the international oil price had slid below 40$ from its peak of over 140$ Actually that oil price low was around 2 years ago and prices have climbed steadily since until, with the crisis in the Arab world, crude went close to 120$ yesterday - Oil prices hit fresh high on Libya fears

Nomura are warning of oil prices above 220$ I am not in the oil price guessing game - who knows? All sorts of things, good and bad, could come out of the crisis in North Africa and the Middle East. Who can predict what discoveries will be made on the supply side.

But one thing I would take odds on is that many commentators and policymakers will use the oil price spike to justify interest rate cuts or, in the case of most countries, to justify delay raising them from near zero.

I have long argued that the deeply negative real interest rates (the UK rate is 0.5% versus inflation of 4-5% depending on the inflation measure you use) is a weapon to be used in extreme circumstances only and for only short periods to get through a crisis. Holding rates too low for too long is extremely dangerous and asking for bubbles and bad lending which store up future crashes and disaster - just ask Spain and Ireland.

The oil price rise will strengthen the hand of the oil price doves on the Monetary Policy Committee of the Bank of England who have been under pressure of late. They will be able to blame high inflation on this "one off, temporary" factor and will point to the danger of raising interest rates when the economy is struggling to deal with an oil price shock. Rising oil prices drain demand from the rest of the economy and higher rates risk doubling the demand shock - households get hit at the pumps and the monthly mortgage statement.

There will be a lot of this kind of talk in coming weeks and no doubt many will refer back to 2008 when many Central Banks raised rates during the last oil spike which some blame for precipitating the economic crisis.

There are several reasons to resist this pernicious logic. One is technical: if monetary policy is to be used at all to control inflation it should be aimed at a general level of prices across the range of sectors which make up our cost of living. Specific rises in one area - energy for example - are not should not be inflationary in general terms. They are a signal that we should use less energy and find more sources of energy to reduce its price. In the meantime we will reduce our spending on other things which should then fall in price. IE a rising oil price should be neutral overall but be a powerful incentive to do the right things to correct the problem (e.g. invest in energy saving ideas).

If we constantly "fight" oil price rises which owe more to long term issues of supply and demand (particularly from the developing economies) with low interest rates we will stop this natural market process from occurring and risk a very serious bout of stagflation like we saw in the 1970s when the biggest ever oil price shock occurred.

Think of the main cause of oil price rises - China. That country's incredible growth (e.g. doubling of car sales in 5 years) is driven by loose money both at home - negative real interest rates while growing at 10%! - and in its main markets in the West. That wild and unsustainable growth in turn causes oil price inflation which causes, um you guessed it, more calls for loose money policies. And it goes on.

We need to recognise that low interest rates are not a panacea. If anything is going to get the Western economies in particular through the economic and energy problems it faces it is more saving and investment, less consumption and debt. Ludicrously low rates are not the answer.

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Interest rates: low does not always mean better

There is something about low interest rates. That they are a "good thing" is deeply ingrained into the psyche. To homeowners they promise cheaper mortgages and higher house prices and to businesses cheaper borrowing and more cash in their customers' pockets. Politicians look to low interest rates as a general economic cure-all.

Indeed a few years back when Labour was trying to persuade Britain that the Euro was a good idea, the main argument was that joining would keep interest rates low. The Conservatives today are arguing for a tough approach to the public sector deficit partly because they say that will keep interest rates down.

But are low interest rates such a great thing? If the government suddenly decreed that it was illegal to charge any interest would that be a good thing? No because it would take away the incentive to save and lend money to people who want to borrow. After all, interest rates are a pricing mechanism designed to balance the plans of savers and borrowers, consumers and investors. Surely what we really need is "correct" interest rates that ensure enough money is saved to finance investment in the economy.

Living in Spain I can visibly see the effects of an extended periods of low interest rates just by looking out of the window. Spain had the low interest rates that Tony Blair tried to sell the Euro using and it stoked a huge boom on the back of consumer and corporate borrowing. Now we see the stalled building projects, shutdown shops and businesses and unsold property that resulted. Spain shows no sign of recovering.

I know a lot of people will say raising interest rates now would be a recipe for "double dip", a slide back into recession particularly if public spending is cut and tax raised at the same time. All I am saying is that let's rebuild the economies of Spain and Britain on sound principles this time. Instead of trying to stoke demand via dollops of public spending, massaging down interest rates and house price booms, let's try and improve the supply side: the workforce, productivity, competitiveness. Meanwhile allow interest rates to settle at a rate that rewards savings to fund investment and stops people taking on debt they can't afford.

My latest column at the Alrroya website covers this topic in more detail Time to Raise Interest Rates

See also a related post What Spanish Pigs Can Teach Us About Economics