Britain’s biggest economic disadvantage - our property market
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MoneyWeek Editor
John Stepek Oct 26, 2012
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It’s official - Britain is no longer in recession.
The economy grew more rapidly than expected in the third quarter of the year, rising by 1% rather than the 0.6% everyone had thought.
Of course, these figures probably over-exaggerate the bounce, just as earlier figures over-exaggerated the decline.
The truth is the GDP figures aren’t useful for much. They’re historic, and they are revised so regularly as to be essentially worthless, except for political point-scoring.
It’ll take more than an Olympic-sized bounce to get Britain – and the rest of the world – out of the hole it’s currently in…
Global growth is too slow to help Britain out of its hole
Just as the British economy was posting its best economic growth in years, companies listed in Britain were running into trouble.
British companies are issuing profit warnings are at their highest rate since 2008, according to Ernst & Young. Companies issued 68 warnings in the three months to the end of September.
As the Financial Times notes, there are two main reasons for the jump, and neither has much to do with the UK.
Firstly, emerging markets are no longer the treasure troves they once were. On the one hand, growth is slowing down in emerging economies, as China in particular slows rapidly.
On the other, there’s far more competition. With everyone viewing emerging markets as the ‘next big thing’, most companies want to do business there. So just as the economies are slowing down, there are more and more rivals competing for what business there is.
This slowdown in emerging markets might not be a problem if somewhere else in the world was picking up the slack. But that’s not happening. Europe is still in the doldrums, and there’s no obvious sign of a rapid turnaround on the horizon.
It’s not just British companies that have been warning of a slowdown. Major US firms – including logistics group FedEx, machinery giant Caterpillar and chemicals maker DuPont - have been blaming the slowing Chinese economy for disappointing earnings. Even the mighty Apple managed to disappoint analysts with last night’s earnings figures.
In short, global growth is slowing, and our politicians and central bankers seem to be at a loss as to how to deal with it.
Britain’s housing market has left the economy paralysed
Ben Bernanke – the world’s top central banker - is not the type to admit to uncertainty, or the possibility that he might be wrong. His solution is usually to do more of what he’s already been doing. So if growth continues to deteriorate, you can probably expect to see a ramp-up in quantitative easing from the direction of the US.
But Sir Mervyn King has always been a more sober-minded chap. It doesn’t stop him from pursuing the same policies as Bernanke, but you sense that his heart’s not really in this great academic experiment into the limits of monetary policy.
He and other members of the Bank of England have warned that the Bank isn’t going to rush into printing more money in November. And it’s not just because of the GDP bounce. It’s because he’s not sure it can solve Britain’s problems.
King reckons – and I wouldn’t disagree – that the basic problem is the banks are still sitting on too much bad debt. The debt needs to be recognised and its value written down (or written off). The banks then need to be patched up. All that needs to happen before banks are willing to lend again.
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“In the 1930s, faced with problems of sovereign and other debt similar to those of today, the pretence that debts could be repaid was maintained for far too long. We must not repeat that mistake.”
However, we are repeating it. The trouble is, the “significant writing down of asset values” that King refers to, would involve allowing house prices to fall. In Britain, house prices are the single most important economic indicator, politically speaking. When house prices are falling, governments lose elections.
It’s why public policy, the tax system, and central bank activities, are all horribly skewed towards propping up the property market. Yet with the banks aware that they are over-exposed to an over-valued sector of the economy, they aren’t going to be keen to lend more until the risk is no longer so high.
This unravelling could take a very long time to play out. We can’t expect rampant global growth to help us out. So the Bank of England will continue to have to walk the line between allowing ‘too much’ inflation to get into the system, and keeping rates low enough to cushion those with large debts. That leaves Britain vulnerable to nasty external shocks.
The US is heading for inflation
But what about the US? As we’ve said regularly, the one big advantage the US has had over the UK and Europe is that its central bank was unable to prevent house prices from crashing. It was painful, but it leaves them in a better position today. Its banks have had to go through some level of purging process at least.
However, they still have a central bank that is dead-set on pumping more money into the economy. If the banks are no longer black holes sucking money out of the economy, then what impact will that have on inflation?
I was speaking to regular MoneyWeek contributor James Ferguson about this the other day. James has consistently and correctly argued ever since the financial crisis that UK and US government debt would remain good investments – a bold call at a time when the rest of us have preferred to avoid them.
But James thinks the time has come to dump any US Treasuries you hold. Why? He believes that the latest incarnation of QE in the US will be genuinely inflationary. That’s very bad news for bonds (fixed incomes become less attractive when inflation is rising). But it could end up being bad news for stocks too – inflation only has to rise to high single digit levels before stocks start to wilt under its pressure.
You’ll be able to read more about why James thinks the big bull market for US Treasuries is over in a MoneyWeek cover story very shortly. If you’re not already a subscriber, you can get your first three issues free here.
• This article is taken from the free investment email Money Morning.
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