There’s no need to talk ourselves into recession

Things are bad enough without talking ourselves into recession.
Some banks and commentators have already called a recession in the USA, when the figures for the last quarter of 2007 show the US economy was still growing well. Here in the UK the retailers have added to the sense of gloom by concentrating on their sales figures on a ??like for like?? basis, leaving out all the sales in new shops.

The current position is both better than the pundits admit, and worse than the government will let on. The bad news is that the banking systems in both the USA and the UK are damaged by discovering that some of the lending they carried out in the heady days of low interest rates and easy money has been in their balance sheets at values that can no longer be sustained. We are living through a difficult time as banks adjust for the losses they have made, and rein in their lending as they are short of cash. In the UK commercial property values are falling fast, undermining the security for some of the loans. Residential property values are under attack from the UK government, who want housing to be more ??affordable??, but are being held up in part by the high Stamp duties and the imposition of Home Information Packs which is deterring people from selling their homes and buying a different one. There are too few homes coming onto the market at the moment to cause a crash in prices. The UK authorities have made the problem worse by their ham fisted approach to Northern Rock and by their failure to keep markets liquid enough during the last four months of 2007.

The good news is that many companies are still trading well. Profit margins are good in many cases, and on both sides of the Atlantic activity is higher overall today than it was when the Credit crunch first hit. Both the US and the UK have experienced a falling currency. As both economies need to divert much more activity into exports, or into import substitution, that will help. Both economies can export so much more to the rich parts of the world ?? China, India, Russia and the Middle East. Both economies now have to seek inward investment from these new giants that have built up huge cash surpluses at the same time as we have built up huge deficits by buying their oil and their manufactures. It is repayment time.

Few forecasters expect a downturn in the UK this year ?? just a sharp slowdown. Some commentators expect the US to get away with a slowdown rather than a recession. The US Fed is very keen to stop a slump, and is taking the right action by making cash available to banks and by cutting interest rates. Now the US President is also promising tax cuts, would boost activity as well. The US authorities recognised earlier than the UK that they had to shift from inflation fighting to recession fighting, and they have been bolder in their actions. They will probably succeed in avoiding recession.

The UKs position is weaker because the UK has increased public spending by too much, wasting too much of the money. At a time when other countries were reining in their public deficits and controlling their spending, the UK government went on a spending binge. This limits the UK governments scope to cut taxes and relieve the pressure on consumers. As consumption is the largest part of activity, this means we are going to experience a slowdown which consumers will feel badly. If the government really wanted to help us out of this change of fortune, it would get a better grip on its spending immediately, cancelling the needless parts like ID cards, computerisation schemes, regional government, and larger EU contributions as well as keeping wages down. Then it could follow the US example and cut taxes to help the hard pressed private sector.

Instead the UK is only going to tackle one of the twin deficits, the balance of payments one, through the mechanism of a cheap pound. Our best hope this year is that the strategy works and the private sector does shift a lot of activity into exports. That could be helped if the government would relent on its planned increases in small business tax and CGT. They need the goodwill of entrepreneurs to right the imbalances in this economy. Its a dangerous time for the government to be sandbagging the very people on whom they rely to recreate their much quoted ??economic stability??. Our economy at the moment is as stable as a row boat in a storm.

There is no need to talk ourselves into recession ?? we can get through with a period of slow growth. To do so, the government needs to curb its own appetite for waste and be realistic about how much it can squeeze out of us in tax.

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9 Comments

  1. Brian Tomkinson
    Posted January 19, 2008 at 11:07 am | Permalink

    So many lies have been told that there is scepticism about any economic statement – particularly from government. Brown's "stewardship" of the economy has been based on profligate state spending and unsustainable consumer debt. This was always a recipe for disaster, the only question being when it would happen. That time has now come and, regrettably, I fear things are going to get a lot worse. Inflation is rising rapidly – particularly in the basic family necessities, as anyone who buys food, energy and fuel will testify. Devaluation of the currency will increase inflation and most people will suffer as a result. Wages and salary negotiations in the public sector are now regularly in the news. The similarities with the 1970s are all too worrying. Labour has shown itself unable and unfit to govern but we need to hear much more from the Conservatives leadership about how they would put this ailing economy back onto a sound basis.

  2. Tony Makara
    Posted January 19, 2008 at 2:43 pm | Permalink

    John, there is a problem here and it is due to our dependence on imported fuel and foodstuffs. Whenever we need to cut interest rates to make more money available it weakens the purchasing power of the pound in relation to those imports and creates inflation. This in turn leads to higher wage demands and we end up weakening the economy even further. This I know that you know already. However I'm interested in hearing what you think we can do to remedy this?

    Reply: The answer is that if we cut interest rates when there is plenty of credit around and sterling weakens, then as you describe we fuel the inflationary spiral. If we cut interest rates when there is a credit squeeze, there is not enough money to allow wages to go up fully to compensate, so we all get a little worse off as sterling falls. It also encourages business to put more into import substtituion and export, which is what is beginning to happen and needs to happen on a large scale. It is certainly working in the US after the big fall in the dollar.

  3. Ed
    Posted January 19, 2008 at 2:54 pm | Permalink

    One tax cut which would be a good investment in the longer term would be to cut CGT to a flat rate of 10% and to slash corporate tax to the same level.

  4. Neil Craig
    Posted January 19, 2008 at 5:46 pm | Permalink

    As you say the good news is that jthe part of the economy that makes real things & provides real services is doing ok it is just the part that depends on the paper prices of things, mainly housing, going up forever that isn't.

    However I think the bad news is that we are growing at 2 1/2% & heve been doing so for a decade while the world average has been 5%. So we have been in comparative recession for that long. This is a much more comfortable bit of managed decline but it still means that the next generation will be poorer than the children of Chinese peasants.

  5. Bazman
    Posted January 19, 2008 at 6:35 pm | Permalink

    I work for a company that makes parts for one of the large 4 wheel drive vehicles, including the most expensive and desirable one. As well one of the most popular cars. A world market. America being the place where most of these vehicles will be sold.
    The number of parts required remains steady with an upward trend.
    A good sign I would say as the one of the first things to be canceled would be the new car when people are worried.

  6. Matthew Reynolds
    Posted January 19, 2008 at 8:27 pm | Permalink

    That is quite right . If Quango spending was halved in five years with many of them either axed , merged , scaled back or hived off then

  7. Matthew Reynolds
    Posted January 19, 2008 at 9:27 pm | Permalink

    That is quite right . If Quango spending was halved in five years with many of them either axed , merged , scaled back or hived off then

  8. mikestallard
    Posted January 20, 2008 at 8:28 am | Permalink

    This socialist government will not cut back on any spending. A leopard cannot change its spots. Also, after ten years of success, it is now playing its second eleven. These are not revolutionary thinkers.
    As things get worse, the government will reach for more taxes.
    It will also print more money.
    This will lead to a resurgence of inflation – look at the gas bills! – and thence to more industrial unrest – especially from the public sector (police, teachers).
    I give this lot until Easter. Already people are talking about a "winter of discontent" – remember dear old Jim? ("Crisis – what crisis?")

    Didn't Mr Brown look at home next to the Chinese Communist leader! Compare that with the pictures of him next to George W on the golfing trolley where he did not look at all at ease. In China his Chinese Black suit and collar and tie corresponded perfectly with his hosts as he inspected the soldiers.

  9. apl
    Posted January 20, 2008 at 11:32 am | Permalink

    JR:

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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