MOAT cleaning services, entertainment system installations, hanging basket planters and chandelier installers: if only the UK recovery story was broader than the fiscal stimulus on which Members of Parliament have been tirelessly engaged.
If only we could all follow their example! Unfortunately, there's a recession on. For a week we were almost able to forget it, and the billowing debt and borrowing mountain that somehow has to be financed.
The details of MPs' expenses have been a
grotesque diversion for many. But for others they were only part of a bigger and more troubling picture of a country that has lost more than its moral compass. The authority of the government has been dealt a massive blow, and at a most critical time. It is hard to see how it can urge restraint and cost cutting and austerity across government spending as a whole when some government ministers have been exposed as politicians on the take. Nor has the authority of the Opposition been much enhanced.
This has the potential to create a dangerous vacuum at a time when the UK needs to raise billions in the debt market – and the price of that debt is contingent on the government being seen as a credible manager of the public finances. We seem to have a political collapse running in tandem with an economic and financial one. On such slippery slopes can countries with a once great past sink to the level of a failed state.
For those outside the political bubble, such a conclusion might have seemed altogether too severe just a week or so ago. Markets both in Europe and America were rebounding on talk of "green shoots" and the prospect of a "V" shaped recovery.
But bleak economic data have caused second thoughts. Bank of England governor Mervyn King gave an impression last week of one deeply unconvinced that the UK economy has yet hit the bottom, never mind starting out on the road to recovery. As I signalled here last week, the Bank lowered its economic forecast for 2009 and now warns of an annualised fall in GDP of some 4 per cent in the summer.
King was in tune with a more sombre mood that had already set in the previous week after the sharp rebound in equity markets. That change of mood has been triggered by three concerns. The first and most obvious is the continuing evidence of a downward push on economic activity. Poor US retail sales data knocked more than 2 per cent off US stock indices in one day.
Nor is there any likelihood of Europe providing a countervailing upward push. On the contrary, data released last Friday by Eurostat estimates that gross domestic product fell by 2.5 per cent in the first quarter of the year in both the Euro area and the wider EU 27 region.
Germany, Europe's largest economy, reported a 3.8 per cent quarterly contraction – the steepest drop in quarterly figures since this data series began in 1970.
And in the UK, brief euphoria over a recovery in mortgage lending and housing demand was quashed by figures showing home repossessions rose by more than 50 per cent in the first quarter of the year.
The second concern is that markets may be falling victim to a deceptive feedback loop. The traditional view is that equity markets broadly reflect business and investor opinion on prospects for the underlying economy 12 to 18 months out.
But markets are by no means a reliable guide to what will happen in the real economy. In March and April of this year, markets have surged on expectations of a recovery setting in by the end of the year. But how confident can we be that this view is any more informed than the view taken by stock markets in the summer of 2007 that there was no serious banking or credit market problem to worry about? Markets duly plunged 40 per cent after this false optimism.
The danger here is that equity market indices are included in most composite leading indicators, thus reinforcing the view that recovery is a "given". But this circularity could be dangerously misleading and cause markets to continue rising solely or mainly on the basis that they have already risen strongly. Share prices rise, causing a presumption that economic prospects are brightening. This presumption helps to boost leading indicator measures, which provides further encouragement to buy equities at yet higher prices.
This circularity could make fools of us all. The scariest precedent for this is 1931.
Can we be confident that we really avoided a Depression – that is, several years of muted economic performance, low business investment, stagnant demand and high and persistent unemployment? In 1931, as now, there were hopes the recession would be short and the world economy would quickly resume its growth path. Signs of recovery were hailed as proof that the worst was over. But bank collapses in Europe brought a dramatic end to such optimism.
The third concern is that much of the "optimism rebound" has been fuelled by fiscal stimulus measures and, in particular, resort by central banks to Quantitative Easing, or expansion of the money supply. This has had the effect of freeing up institutional funds for investment in equities. So what happens when "QE" is withdrawn? Markets will need to see a credible exit strategy as the year progresses. But it is far too early yet to have confidence that the slowing of the rate of activity decline will develop into a sustained recovery. And there is every sign that bank lending will continue to be subdued as loan books, particularly those sections secured on commercial property, deteriorate further. The evidence from business points to a sharp fall in the rate of de-stocking. But that is not at all the same thing as a revival in final demand and in investment spending.
The likelihood is we are set for a prolonged period of subdued growth with no early sign of an end to rising unemployment. Not only does the worst still lie ahead for the real economy, but a gruelling test of the government's authority over spending and borrowing has also still to come.
The full article contains 1050 words and appears in Scotland On Sunday newspaper.
