Thursday, 8 May 2014

Britain's Strange Recovery - Part I

It's a strange thing: one of the world's larger economies, almost uniquely exposed to the financial crisis and wrestling (albeit half-heartedly) with a super-sized state and super-sized fiscal deficit, looks about to escape the clutches of the dour 'new normal'.  Yet it is not clear how or why Britain is managing such an unlikely feat.

None of the common/popular explanations are consistent with the available data; but neither are explanations featuring malinvestment resolution followed by a re-investment cycle. Even more extraordinary, despite a quantitative easing program, the recovery is happening despite negligible broad money growth, if any.  It also features employment soaring at a time when labour productivity is plunging.  

So Britain's recovery is a challenge to a large number of economic (and political) assumptions. Despite this, I believe that although the recovery has some rather unusual features, it is economically explicable and, although hostage to policy mistakes, sustainable. If so, it is worth investigating to see if it contains any features which might be useful to other countries.  Alternatively, it may be that the recovery is based on features which are not easily replicable elsewhere.

The first job, however is to sweep away various popular views of the recovery.

It's a credit-fuelled consumer boom Every part of this assertion is contradicted by the available evidence. First, credit is not soaring – it's not even expanding. In the 12m to March, bank lending to the private sector contracted by 3.4% yoy, or by £68 billion. Nor is this new: at the onset of the financial crisis, the British private sector owed the banks a net £293bn (ie, that was the surplus of private sector loans minus private sector deposits). By March 2014, that had turned into a net £155bn deposit position, with £82.5bn being added in the last 12 months. The British private sector has repaid an amount equivalent to £448bn in net debt, equivalent to 21% of the current gross outstanding loans by banks to the private sector.

Is this situation challenged by lending outside the banks? Hardly: consumer credit (ie, unsecured debt) extended by non-banks rose by 3.5% yoy in the year to March, with the stock rising by £1.78 bn during the year, but it is still £11.8bn lower than its peak in Dec 2008.

And is it a consumer-boom in the first place? Retail sales rose 4% in the 12m to March, with the 6m momentum trendline exactly in line with the trends established during the previous five years.  The latest GDP data breakdown by expenditure is for 4Q13, and it reports household consumption rising by 0.4% only,  underperforming the total 0.7% GDP rise, and contributing only 0.3pps to that growth.   Household expenditure's contribution to 4Q;s GDP growth was no larger than that of gross fixed capital formation, and less than the contribution made by net exports.

Whatever else it may be,  the UK is not undergoing a  'credit fuelled consumer-led recovery.'

It's a housing bubble Whether you are British or not, if you work in the financial services industry the chances are that when you think of Britain, you think of London.  (One of my earliest memories in the business was listening to David Roche – then Morgan Stanley's strategist – talking about the British economy to a Canary Wharf room full of the firms' London best.  'Has anyone actually ever been outside London?' he asked – and I don't think it was a rhetorical question. Anyway, the room giggled nervously).  If your view of Britain is in fact a view of London, then you will believe, correctly, that you are in the middle of a housing bubble.

If you live outside London or its immediate surroundings, you will know this is simply untrue of Britain.  There are various indexes tracking regional price movements, but the Nationwide survey is the one to hand. It shows London prices up 18.2% yoy in 1Q, whilst for the UK as a whole the rise was 9.2%. In the North the rise was 5.9%, in the Midlands around 7%,  the South West 7.4%, Scotland 7.6%, Wales 5.2%, Northern Ireland 5.4%.   Whilst London prices were 19.4% above the UK 4Q07 peak, prices in the UK, including London, were still 3.2% below that peak.  For considerable parts of the country, prices remain below peak levels by around 10% or more.

All things consider, it should not now come as any surprise that we don't have a recovery 'fuelled by mortgage debt.' In fact, the total amount of outstanding debt secured on dwellings (ie all sort of mortgage-debt) rose by just 1.03% yoy in March.

One of the chief policy dangers Britain faces is the seeming inability of London-centric policymakers to understand that whilst London has a rather obvious property problem, the country as a whole does not. The clear danger is that if policymakers are unwilling to adopt policies specific to controlling London's property problem, it will be left to the central bank alone to tackle the problem. Not only will that unnecessarily burden the rest of the country with London's problem, but since London's problem is evidently not primarily being financed by mortgage lending (as the mortgage data shows), raising interest rates is unlikely to deal with it anyway.

Actually, I think the London property market is playing an important role in the UK's recovery. But the role it plays for the rest of the country is anything but obvious.

All the growth is in London Once again, this is an assumption made by commentators who rarely find themselves straying outside the M25, and is then foolishly yoked together with the 'property bubble' error.   But once again, it is clearly not true.  The key here is in the employment data.  Since early 2010, the UK has added 1.56mn jobs, a rise of 5.4%. London's employment during this period rose by 8.6%, but it was closely followed by East England 7.2%, Yorkshire 6.9% and even the South West +6%.   During the last year,  London has no longer seen the most rapid increase in employment: rather, London has been outperformed on job-creation by the South East (up 3.5% yoy), North East (up 3.4%), the South West (up 3%), Wales (up 3%) and even Northern Ireland (up 2.8%).  In fact, fully two thirds of the new jobs created in the UK during the last year are located outside London and the Southeast.

Growth is 'Unbalanced'  I suspect this is a derivative of the 'it's all to do with London's financial services and property' error.  It is, however, worth noting two things which this vague critique overlooks. First, the 4Q13 GDP estimates show manufacturing growth keeping pace with overall GDP growth (both at 0.7% qoq). Second, traditionally, the measure of Britain's 'unbalanced' economy is the way its trade balance deteriorates as growth accelerates.  Except that during this recovery, Britain's trade position is improving, not deteriorating, in both nominal and proportionate measures.

I hope I have established that the current UK recovery is not a credit-fuelled consumption-led recovery; that it is not primarily a property bubble, that it is not a recovery confined to London, and that it is not 'unbalanced' in the sense usually applied to the UK economy.  But if it is none of these easily-recognizable things, and if, moreover, quantitative easing has largely sabotaged the tough resolution of dissolving the malinvestment of the previous cycle, we are left with a puzzle. Just what is allowing the UK to reach something approaching escape velocity?

If we're going to find an answer, we will have to reach back to more fundamental questions involving inputs to growth.  And we shall also have to consider the mechanics of money creation in a time of effectively zero credit growth. Of which more next time. . . .

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