The moral: A lot can
be going right in an economy, but you won't notice it whilst zombies
stalk the financial system.
The week after the
Budget is not a bad time to take another look at the British economy.
Were on to judge from newspaper headlines or the ex-cathedra
pronouncements that the BBC mistakes for journalism you'd conclude
there's little hope.
In fact, that's wrong:
there's a surprising amount to like about the British economy right
now: from my analysis, I think:
- Asset turns are about the highest they've ever been.
- Labour productivity has grown consistently mid-2009 and is now 2.6 Standard deviations above the 1998-2008 trendline.
- As a result of that, employment is growing – the latest data shows employment up 2.1% - and there's nothing mysterious about that strength.
- When you measure domestic demand momentum by looking at retail sales, vehicle sales and employment, you'll find the underlying 12m momentum is rising the fastest this century.
But there's one thing
seriously wrong: zombie banks stalk the land plunging monetary
velocity ever-lower. The unwillingness or inability to deal with the
zombies immediately after the crisis of 2008/09 is by a very
considerable Britain's biggest economic problem. It is truly
disabling that Britain's politicians do not see this. Unwillingness
to encourage and foster the development of a new and clean set of
financial institutions – universally-distributed money market
mutuals are the obvious vehicles – are the single major stumbling
block to recovery.
Does the bullet-point
list of good news seem implausible? Here's how I reach the
conclusions.
Asset Turns &
ROC Directional Indicator
First, I generate the asset-turns /ROC
directional indicator in the same way as I do for any other country,
by looking at nominal GDP as a flow of income produced from a stock
of fixed capital, and then estimating that stock (and its changes) by
depreciating all gross fixed capital formation over a period of 10
years. On these calculations, Britain's stock of capital shrank by
0.7% in 2012, whilst nominal GDP rose 1.5%, so asset turns continue
to rise. In the face of rising ROC, gross fixed capital formation
rose 1.4% in 2012, after shrinking 2.9% in 2011. In the absence of a
major investment cycle, ROC will continue to rise during 2013.
Of course, in the face
of bank deleveraging, the vigour of the investment cycle will be
constrained by the limits to which investment spending can be
financed by cashflow. Nonetheless, one should certainly expect
investment spending to continue to rise.
Rising Labour
Productivity
Labour productivity is
one of those concepts who's simplicity disappears as soon as you try
to grasp it: if you are willing to overlook that, you will find
current British labour market conditions baffling, with GDP basically
flatlining, how can employment be expanding so vigorously? The key
is this: merely looking at GDP per worker takes no account of changes
in capital inputs. If workers' productivity rises are merely the
result of a rising capital/worker ratio, ideas about 'effort' and the
contribution of 'skill/experience' are lost. That seems wrong. So I
measure GDP per worker, but deflate the number by changes in capital
stock per worker. This calculation tells us that output per worker,
minus changes in capital stock per worker, rose by 0.8% in 2012,
having risen 1.4% in 2011 and 2% in 2010.
Now, some labour
productivity gains are always experienced coming out of a recession
purely as a result of operational leverage. The key point to realise
is that the gains in productivity have passed that point: in fact
labour productivity had regained the long-term trendline by mid-2011.
By end-2012 labour productivity was 2.6SDs above that line. Breaches
of that size suggest a secular change in trend – for the better -
is now being discovered.
Such a change would
help explain the rise in employment which otherwise might seem
baffling: the number of people in jobs began to rise first in early
2010 (the initial response to rising productivity), took a breather
throughout most of 2011 before rising again sharply in 2012 (as
productivity broke through the trendline and kept on growing). In
the three months to January 2013, employment was up 2.1% yoy, and in
the 12m it was up 1.3%.
And there is another
aspect to this: if investment in capital equipment is constrained by
the lack of bank lending and expansion has largely to be financed
through cashflow, and if capital and labour are to some extent
fungible, then it may make sense for companies to take on more
workers rather than buy new machinery. Ironic perhaps, but if credit
constraints go hand in hand with positive cashflow, a substitution of
labour for capital would allow rising employment to coexist with
falling capital stock and flat GDP.
Domestic Demand: 12 Momentum Strength
Even if you have
followed me so far, the next step will probably prove a step too far:
domestic demand is no longer 'flat on its back' but rather has
developed considerable underlying positive momentum. I freely grant
that this is not obvious from recent monthly data: but this is partly
because it is difficult to see through its unusual volatility.
Looking at the 6ma deviation from seasonal trends, positive momentum
had been maintained since May 2012 – the longest positive
uninterrupted run since 2006-2007. More, this run has taken the 12m
momentum to the most positive point in recent British economic
history.
Such a positive reading
is difficult to accept, as it runs absolutely counter to the popular
economic narratives heard in the UK. Still, on a 12m basis:
- retail sales values are rising by 2.7% yoy, which is approximately the annual average achieved since 2008;
- car registrations are rising 6.4% yoy, vs a post-2008 average of minus 1.4%
- employment is up 1.3%, which compares with a post-2008 average of 0.2%.
The underlying
improvement in the economic data is unrecognized both in popular
economic narratives, but also in consumer confidence indicators,
which show no sign of uptick at all.
The Problem: Zombie
Banks
One reason is that
Britain's fundamental problem remains unaddressed: its banks are
still effectively zombies. This really is all over the data: in
January M4 was down 0.2% yoy, the 24th successive monthly
of yoy contraction; outstanding sterling bank loans have fallen 7.8%
over the last three years, and shows no sign at all of recovery; the
British Bankers Assn today reported Feb mortgage loan approvals down
7.1% yoy in value.
This is no longer a
matter of the net credit-worthiness of the private sector: currently
the private sector holds £51bn of net deposits in Britain's banks, a
reversal from the immediate pre-crisis peak net indebtedness of
£293bn of October 2007. Nor is a lack of loan-demand responsible:
Bank of England credit condition surveys for 4Q12 found the highest
demand for both secured and unsecured lending since the immediate
onset of the crisis.
Rather, the problem is
that the banks are either unwilling or simply unable to lend. Having
spent time in Japan, the problem is very familiar: they are simply
zombies. One result is obvious: with zombies stalking the financial
system, monetary velocity is unable to rise, and nominal GDP is
constrained.
(Footnote about
Volatility: One can, of course, set against that weak industrial data
(exports, industrial production), but there's a serious caveat
hanging over these data series in 2012, with the seasonal adjustment
process generating a volatility quite unprecedented in both series'
previous history. Faced with such an outbreak of volatility, one
would naturally assume 2012's data 'comes from a different
population.' Having written to the ONS about this, I can assure you
that they are as puzzled/worried about it as I am. For the time
being, I think you can't base an argument on this data.)