The ‘real’ economy is suffering as much as the financial one
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Associate Editor
David Stevenson Sep 18, 2008
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It’s been a wild week in financial markets. But if you’ve had nothing to do with Lehman Brothers, or aren’t on the payrolls of Merrill Lynch, AIG, HBOS or indeed any of the other firms starring in the latest act of the credit crisis, the chances are that your world is still revolving - more or less - normally.
However, almost unnoticed amid the havoc, there have been several reminders over the last few days, on both sides of the Atlantic, that the overall levels of suffering in the ‘real economy’ just keep building up.
In other words, things are already getting markedly worse, even before anything like the full knock-on effect of the City’s latest woes starts to kick in.
About a month ago, I pointed out that the UK Misery Index, which is measured by adding the rate of inflation to the unemployment level, had hit 9.8, its highest point for almost 12 years. Now we have a new high.
The August consumer price index (CPI) hit a 16-year high of 4.7% as gas and electricity prices went through the roof and food costs boiled over, while unemployment also climbed at its fastest rate since 1992 to a nine-year high of 5.5%. So with a combined reading of 10.2%, Britain is now officially at its most miserable since the end of 1995.
Yet Bank of England Governor Mervyn King isn’t too worried on the longer-term price front. Although he sees CPI growth reaching 5% “soon”, in the ‘open’ letter he had to send to Chancellor Darling explaining why inflation is so far above the 2% target, he says consumer price rises should drop “sharply” in 2009 and “fall back to target thereafter”.
That means that in theory, he and his friends on the Bank’s Monetary Policy Committee should be able to begin slashing interest rates next year, allowing both home and personal loan costs to drop.
That’s good news, isn’t it? Well, sadly there’s a couple of snags. The first is that for this ‘success’ to be achieved, the economy has to stop dead in its tracks. “Activity growth remaining muted” is how the Governor puts it, but that sounds a tad optimistic to us.
Capital Economics expects a rate cut as early as November because “other news suggests the economy will be in a perilous state by then”. Worse, “a rise in unemployment of around 1m will add to the pressure of falling house prices and declining real incomes.” Sounds like Britain’s Misery Index is still heading quite a bit higher.
The second is that the banks that manage to survive the current cull aren’t going to be very keen, or indeed able, to lend as much as they have before, as they run ever lower on capital. We’ve already written about this: Why your bank manager may be about to turn nasty – but since then, everything has got a good deal worse.
This week the bankers were so collectively spooked that they didn’t want to lend any cash to each other, let alone their poor customers. Overnight sterling LIBOR – the London interbank offered rate which banks use as a measure for loan advances between themselves – rocketed to almost 6.8%, compared with the ‘official’ rate of 5%, as panic set in. And though money rates have since dropped back, the chances are we’ll see a repeat the next time a bank reaches the brink.
Meanwhile, in the Land of the Free, amid all the frenetic nationalising there have also been some grim ‘economic releases’.
Inflation actually fell for the first time in two years as oil prices eased, but the year-on-year rate still stands at 5.4%. Add in the 6.1% unemployment level reached earlier this month and the US Misery Index is still climbing. Throw in a fresh 17-year low in housing starts on top of that, and a 26-year low in new building permits and it hardly looks like confidence is returning to the residential property scene, either.
Perhaps the sad state of affairs is best summed up by the news that the interest rate on US Treasury three-month bills – securities issued by the government to raise money - dropped yesterday to its lowest, 0.233%, since at least 1954, when daily records began. Despite the compulsive desire of the US authorities to mop up most of the losses racked up by big-gambling financial business bosses and load them on unsuspecting taxpayers, investors are still piling into US government debt.
At the same time, the Reserve Primary Fund, the oldest US money market fund (they’re supposed to be about as safe as you can get) has ‘broken the buck’ by becoming the first money market fund in 14 years, and just the second ever, to serve up losses to investors after writing off $785m of debt issued by Lehman.
“It’s scary”, says Craig Coats at Keefe, Bruyette & Woods, who started trading bonds in 1969, “this is the worst it’s ever been since I’ve been in the business. Nobody knows what’s really going on”. Investors are “extremely cautious with respect to who they're lending money to at the moment,'' said Richard Bryant at Citigroup Global Markets, “they're willing to pay for the privilege of knowing their money is safe.''
But US government debt - safe? Really? The cost of insuring against the default of long-term US Treasury bonds has just jumped to an all-time high as the country’s liabilities stack ever higher. It’s much more likely that lending to the US government is seen as merely the lesser of all evils. As the FT says today, “mattresses have never looker better”.
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