Sunday, May 07, 2006
Is it springtime for Gordon?
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

After my excursion last week into global warming, on which more soon (the Treasuryís own review under Sir Nicholas Stern will report in the coming months), the weather has obligingly warmed up. So, it seems, has the economy.

The dark days of winter, when it seemed retailers could not sell a pair of socks, have given way to tentative spring optimism. Britainís beleaguered manufacturers, apparently reconciled to missing out on the global boom, have belatedly joined in the fun.

The housing market, which has been showing strength for some months, continues to move ahead, house prices, mortgage loans and approvals trending strongly higher. Last yearís property worries are rapidly fading in the memory.

Britainís economy, meanwhile, has been much in demand this year. Foreigner firms increased their ownership of British companies to the tune of £19.3 billion in the first three months of the year, compared with £5.1 billion of UK acquisitions of firms overseas. Netted out the M & A (mergers and acquisitions) inflow in the period was more than £14 billion, the highest since 2000.

So is it springtime for Gordon? Are the figures a ringing endorsement of his view that last yearís slowdown was just a blip, or even a statistical aberration? If so, this has many implications.

It would mean, amid the governmentís sea of troubles, the economy continues to sail on serenely. If you believe, like me, governments only lose elections when they no longer have the publicís confidence in their ability to manage the economy, the Tories still have work to do to prevent Gordon Brown winning his own term as prime minister in three years time.

Stronger growth also has clear implications for the public finances. It would lend support to the view that the chancellor has got away with it, avoiding a big new tax hike while relying on economic expansion and fiscal drag to quietly boost tax revenues to record levels.

So how real is it? Let me look at the upturn evidence. Growth in the first quarter, 0.6 per cent, was marginally below trend and similar to that achieved in the final three months of last year. But year-on-year growth picked up from 1.8% to 2.2% because of base effects (favourable comparisons with weak growth a year ago).

The current profile provided by the Office for National Statistics, which is of course always subject to revision, suggests the low point of the cycle was more than a year ago, in the first quarter of last year, when gross domestic product rose only 0.2%.

Britainís manufacturers, who managed a 0.5% increase in output in the first quarter, saw a further strengthening in April with their best performance for 17 months, according to the purchasing managersí index (PMI). The PMI for the service sector also rose impressively, and was its best since as long ago as January 2004.

Retailers, who struggled in the first three months of the year, had a much better April, according to the CBIís distributive trades survey. Part of that was due to the late Easter (which fell in March last year) but it is a while since we heard mainstream retailers bleating about lack of business. Iím still old-fashioned enough to regard Marks & Spencer as a bellwether of the high street, and whatís good for M & S tends to be good for the economy.

The housing market, meanwhile, is proving once again that it does not stay docile for long. The Halifaxís report of a 2% jump in prices last month, 4.4% since the start of the year (and 8% over the past 12 months) probably overstates it. Bank of England figures for mortgage approvals, 116,000 in March, were marginally weaker than earlier in the year. But there is a lot of momentum in the market. The British Bankersí Association said that gross lending to individuals, £17.7 billion, was a March record.

Taken together, all this implies there is no case for a reduction in base rates. I certainly would not be voting for one. Indeed, I must confess to a moment of nervousness at noon on Thursday, on the off-chance that the monetary policy committee(MPC) announced a pre-emptive hike.

Significantly, while the CBI said it was disappointed the Bank had not cut, other organisations, notably the British Chambers of Commerce and the Engineering Employers Federation, stuck to warning the Bank off a hike.

It becomes possible that the four members of the MPC who were unhappy with last Augustís rate cut from 4.75% to 4.5%, will succeed in clawing it back. We are, I hope, some way from that. But things have definitely changed. Is there anything that could change it back?

One possibility is that the world economy, currently going through a purple patch, starts to misbehave. Stephen Roach, Morgan Stanleyís chief economist, has been the arch-bear of recent years. Now he confesses to being more upbeat, because he thinks the great imbalances are being tackled.

Without wishing to out-growl the bear, if we are seeing the start of the dollarís big fall, that could be destabilising. It means. already, that sterling is holding at well above $1.80. Oil could do damage too, despite its benign impact so far and its fall from the $75 peak. The Iran hurdle remains a big one to negotiate.

At home, meanwhile, manufacturing has seen plenty of false dawns before. The consumer story for this year has been one in which gradually rising unemployment, aversion to taking on more debt, rising utility bills and petrol prices and the creeping increase in taxation were all taking their toll on spending. Easter may have boosted things a little, as has recent fine weather, but it is too soon to call a sustained upturn.

That also goes for other components of spending. Business investment has yet to show itself and a strong upturn in exports is balanced by even stronger imports.

Perhaps the best way of assessing it is that the economy has shrugged off its weakness of last year. But it has yet to show the kind of rapid growth that would trouble the Bank, however. Or for that matter help the government get the bad news off the front pages.

PS Corrections and amplifications. Tony Blair kept saying last week that on the real Black Wednesday, September 16 1992, interest rates went up 6%. Heís exaggerating. They rose 5%. from 10% to 15%, and the second part of that rise, from 12% to 15%, was cancelled before the day was out.

Returning to global warming, some were confused by the chart with last weekís piece. The original is on p17 of the House of Lordsí Economics Affairs committeeís report on climate change economics, available on

Migration Watch has also offered a corrective to last monthís report by the Ernst & Young Item club on the benefits of immigration in the form of stronger growth, and lower inflation and interest rates. According to Migration Watch, these supposed advantages are cancelled out by a 50,000 rise in unemployment, damage to the low-earning indigenous population and the fact that when dependents are taken into account, population increases as much as economic growth.

Finally, a report on my search for the best value goods or services you can buy these days. Theyíre flooding in. Iíve now got transistor radios, so cheap they sometimes give them away; DVD players that cost less than the movies you buy to play on them; and websites, which in the mid-1990s used to cost at least £250,000 to set up, and can now be a thousandth of that. I also liked the domestic copper hot water cylinder; use it for decades and sell it for scrap, at current record copper prices, for a tidy profit.

Iíve also got what may be an example of the worst value for money; 50p to spend what used to be an old penny at Westminster Tube station.

From The Sunday Times, May 7 2006


Don't forget Dave the eighties house crash had a short periods of recovery on it's way down. We're not out of trouble yet. Interest rates may well be on the way up.

Posted by: Werewolves at May 7, 2006 12:56 PM

Isn't a rise in interest rates from 10 per cent to 12 per cent an increase of 20 per cent?

Posted by: excession at May 8, 2006 07:03 AM

David, your article at the weekend in the Sunday Times proclaimed that Britons are wealthier than ever before, and that the wealth:

"... consists mainly of savings, shareholdings and accessible housing equity, net of mortgages and other debt".

Only in a bulls eyes (or a dishonest accountant's) can a million pounds borrowed be equated with a million pounds wealth!

Even more worrying is that your article concludes:

"... household balance sheets remain in generally good shape"

But perhaps you didn't read Duncan Gordon's article "Record numbers go bankrupt as debt mountain builds up" from the previous day's Times, where he wrote:

"The first quarter total (debt) eclipsed the previous peak set at the time of the early Nineties recession"

Aye Carumba!

Posted by: Paul Owen at May 8, 2006 12:24 PM

I would agree with Paul. Gains in housing equity only represent wealth if you are net long housing. And as most homeowners own only one home, and need one home to live in, they are housing neutral, not long.

All you can do is downsize to a smaller house (which will also have risen in price), in which case your a trading some of your standard of living for cash, so you are not - net - any better off as a result of house price rises. Most of the 'profit' you make will be forced saving from having paid some of the principal on your mortgage.

Or you can borrow more against your equity, in which case you are in debt, and are not - net - any wealthier.

Those with real cojones can go short and sell to rent, but I don't see to many people doing that!

It's not a profit until you take the money off the table! Don't believe the hype!

Posted by: El_Pirata at May 8, 2006 07:04 PM

In response to Excession, a rise in interest rates from 10% to 12% should properly be described as a rise of two percentage points. It does indeed represent a 20% increase in the cost of borrowing but it we started desciribing it like that everybody would get confused.

It may be the way it was phrased but I'm not sure that Paul and El Pirata have got the point about wealth and household assets. The figures quoted were net of borrowings. For housing, in other words, it represents net equity - after any mortgages have been taken into account. Any company that had assets five or six times the value of itrs liabilities would have a healthy balance sheet. That is the position of UK households - assets total roughly £7,000 billion, liabilities roughly £1,300 billion.

Everybody has to know that the rise in personal bankruptcies, while partly reflecting debt distress at the margin, is mainly a function of the change in the law.

Posted by: David Smith at May 9, 2006 09:00 AM

Everybody has to know also that unmanageable personal debt is the same however it's dressed up.

We'll only know for sure if the rise in personal bankruptcies is due to the legislative revision or a genuine debt problem after the next rate rise.

We did understand the point about housing equity - as pirata says housing prices rises do not translate to disposable income because they are not liquid assets. Agreed , some might then borrow against that increase but that's not wealth - that's still borrowing based on asset security.

Posted by: Paul Owen at May 9, 2006 12:23 PM

No, it is wealth. Borrowing against housing equity merely makes that wealth more liquid. The argument that if everybody tried to cash in their housing wealth at the same time it would disappear is irrelevant. Not only would that never happen - net housing demand will be rising for the foreseeable future - but it is a bit like saying that if everybody tried to get their cash out of the bank at the same time only a fraction would be able to do so. Perfectly true, but it does not make us think our bank deposits are only worth a fraction of what our statements say.

Posted by: David Smith at May 9, 2006 02:42 PM

Think of it like the contract Ethan Hawke takes out in Gattaca - 10% of his future earnings for a career ladder now - he's sacrificed an amount in the future to spend today.

When you borrow against the value of your house, surely you're shaving off a section and saying to the bank "here liquidate this for me". But that piece of house you've liquidated now is gone - you spent it.

Definitely not wealth. Because you're still borrowing from the future to spend now.

Posted by: Paul Owen at May 9, 2006 05:21 PM


I guess we are coming at it from 2 different perspectives - you from a company balance sheet perspective and me from a trading book perspective.

You may have net equity after borrowings have been taken into account, but you are still not "net long" housing as an individual. It's like saying you have made a profit because you have a full tank of gasoline in your car and gasoline futures just went up. You could sell the gasoline in your car, but you wipe that profit out when you have to refill the tank, because the price you pay at the pump just went up too. Or do you just never drive a car again?

"Borrowing against housing equity merely makes that wealth more liquid" - no, because you have to pay a loan back. Your house is not going to pay that loan back for you unless you sell it, and then you are short one house!

Posted by: El_Pirata at May 9, 2006 05:49 PM

I think we're getting there. Yes, if you borrow against your housing equity your net wealth has gone down - you've drawn on it. If you don't borrow against it, it remains as wealth, to be used later (if you trade down in the housing market) or to be passed on to your beneficiaries and the taxman when you yourself pass on. That is what wealth is.

It is a fundamental point that the value of the housing stock, net of borrowings, is a component of household wealth, about half, the other half being in the form of savings, pensions and other investments.

If you're saying that most people are already struggling to meet payments and can't borrow more - even against their housing equity - that's a slightly different point. But it doesn't happen to be true at the moment.

Posted by: David Smith at May 9, 2006 06:18 PM

"Everybody has to know that the rise in personal bankruptcies, while partly reflecting debt distress at the margin, is mainly a function of the change in the law."

While I am sure this is true, surely there are consequences to rising bankruptcies? There are creditors who don't get paid, banks with increasing bad debts on their books. These things have a tendency to snowball.

Just because it is easier for the debtor to go bankrupt, it does not mean that the impact on the economy is less malign. We can't just say oh it doesn't matter, it's all just down to a change in the law. (I'm not suggesting you were implying this David!).

Posted by: El_Pirata at May 9, 2006 06:28 PM

That's true. So far the numbers are too small to have much of a macroeconomic impact, but they have led to a rise in the banks' bad debt provisioning and cause plenty of problems for small firms and other debtors.

Posted by: David Smith at May 9, 2006 06:48 PM

Excuse me for this nagging imposition but I'm still uneasy with the idea that borrowing against a future price rises of an asset constitutes wealth, so David when you mention that

"borrowing against housing equity merely makes that wealth more liquid" *

still doesn't look quite right, because you forgoe future (accrued) wealth by borrowing against current (or projected) value. Or am I missing something?

* a rise in lending rates would - admittedly - make the bank wealthier in this scenario ...

Posted by: Paul Owen at May 9, 2006 11:00 PM

I think you are missing something. We're not talking about future wealth, we're talking about wealth that is already there, in the form of assets. Now, if you were to borrow on the expectation that your house would be worth three times as much in 20 years time, that would be a different proposition.

Posted by: David Smith at May 10, 2006 09:49 AM

Okay thanks I see.

But even borrowing against a price rise since originally purchasing the asset is still carrying forward a debt (against the asset) until you sell it.

So still not wealth creation then.

Posted by: Paul Owen at May 10, 2006 12:36 PM

Oh, and Mervyn King mentioned today:

" ... so I think the signs are that a potentially large social problem, with many households getting into difficulty with their debts, is materialising."


"The level of house prices still seems remarkably high relative to those measures that put it into context."

Spring time for Gordon Brown? Or high time?

Posted by: Paul Owen at May 10, 2006 05:16 PM

The wealth point is about as basic as it gets. If you've got a painting, it's wealth. If you've got stocks and shares, it's wealth. In each case you realise that wealth by selling. The current value of that wealth is determined by market prices now. Ditto with housing. But those nice bank and building society people will also let you get access to that wealth early by lending to you against it. But you don't have to do that. You can keep it as unrealised wealth. Wealth is not just five-pound notes in a tin under your bed. As I say, this is very basic stuff.

As for Mervyn King, he was careful to describe debt as a social problem, not an economic problem, which has long been the Bank 's position. And those conventional measures of housing have been telling that story for a long time. The question is whether they are relevant any more.

Posted by: David Smith at May 10, 2006 11:07 PM

Mervyn Kings statements were very guarded, that true.

Coming back to this point though I was just surprised that you said this:

"Borrowing against housing equity merely makes that wealth more liquid."

As you say, let's forget housing - let's look at a fictional painting instead.

Suppose you bought a painting for £5 last year. It's now worth £10. You go to the bank and say "I want to borrow £5, secured against my painting". The bank agrees on your estimate of its current market value and lends you the £5.

(on the other hand of course, the bank will lend you any amount secured against any asset, as long as you're not looking to borrow more than the value of the asset!)

At this stage, if your painting gains in value even more, you will profit from that gain MINUS the £5 which you owe the bank. If you sell the painting now or in a year's time, you will STILL OWE that money.

So then how does that £5 which the bank lent you last year constitute wealth? The answer is that it doesn't at all.

Lending is still lending and as I mentioned very early on a million pounds borrowed does not make you a million pounds wealthier, because when you borrow against an asset, you are actually devaluing it by that amount.

Posted by: Paul Owen at May 11, 2006 12:59 PM

We're there! This is what I posted a few days ago:

"Yes, if you borrow against your housing equity your net wealth has gone down - you've drawn on it. If you don't borrow against it, it remains as wealth, to be used later (if you trade down in the housing market) or to be passed on to your beneficiaries and the taxman when you yourself pass on."

So, as I've been saying all along, housing equity net of borrowings is wealth. Can't understand what all the fuss was about

Posted by: David Smith at May 11, 2006 02:02 PM

What you posted was in answer to the following:

Me: "some might then borrow against that increase but that's not wealth - that's still borrowing based on asset security"

You: "No, it is wealth. Borrowing against housing equity merely makes that wealth more liquid."

The asset is wealth from a balance sheet perspective (whether you borrow against it or not), but as I said initially (which you first disagreed with at first but now concede), the sum you borrow is not wealth.

Posted by: Paul Owen at May 11, 2006 02:26 PM

Yes, perhaps I could have been clearer, but I've been trying to say the same thing all through. You've got wealth tied up in housing - the value of the property less borrowing. By borrowing against it, you are making a decision to use that wealth now - you've made it liquid. But clearly you can't use the same wealth twice. By increasing your borrowing you've turned that wealth into cash, but the counterpart to that is that you've plainly also reduced your housing wealth.

Posted by: David Smith at May 11, 2006 03:02 PM

Yes! that's it. Thanks for your patience.

Posted by: Paul Owen at May 11, 2006 03:14 PM
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