Sunday, March 23, 2008
Remembrance of grim times past
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


IF you can keep your head while others are losing theirs, better not shout about it in today’s environment. What would Rudyard Kipling have made of a frenzy that has taken us from the possibility of recession to a re-run of the Great Depression in days?

We should treat talk of another Great Depression with a similar pinch of salt as when it was predicted after the 1998 global financial crisis and the September 11 attacks on America in 2001. But if those who ignore the lessons of history are condemned to repeat mistakes, nobody knows better than Fed chairman Ben Bernanke the lessons of the Great Depression era — you do not allow the banking system to implode and compound the problem with a protectionist trade war. Even if the historical parallels were appropriate, which I think they are not, the lessons have been learnt.

As an aside, many people think the Great Depression was the source of the observation that, if America sneezes, Britain catches a cold. That was not the case. America’s gross domestic product (GDP) fell by about a third from 1929 to 1932, while Britain’s dropped by only 5%, followed by the long upswing to 1938.

It was grim, particularly up north, although the 1930s was also a time when the consumer age flowered. Many of those three-bed semis that make up our suburbs were built, UK car output rose fivefold between 1924 and 1937, and electric cookers, vacuum cleaners and washing machines began to come within the reach of ordinary families.

If not depression, then, what about recession? Britain is just approaching the end of a quarter in which GDP will probably have grown by 0.4% or 0.5%, down only a little from the 0.6% recorded in the final three months of last year. This will be the 63rd consecutive quarter of growth.

Growth has slowed but no more than anybody expected. Indeed, the evidence of recent days points to an economy which, if not booming, is defying any crisis. Retail sales rose by 1% last month, following a 1.1% increase in January, and are up by 5.5% on a year earlier.

The figures will have come as news to many retailers, for whom life is a struggle, but suggest the consumer is a long way from collapsing. Manufacturers are experiencing a healthy rise in orders, particularly in export markets, according to the CBI. Its measure of export orders has just equalled its best reading since 1995 and price pressures are persisting.

Is the job market buckling under the impact of the credit crunch? It has not happened yet, despite some evidence of job losses in financial services. Employment overall rose by 166,000 in the three months to January and unemployment dropped by 32,000. The claimant count continued to fall last month.

It is not stretching it too far to say that, if the Bank of England closed its eyes to the credit crisis, it might be thinking of raising interest rates rather than cutting them further. Everybody thinks employment and unemployment are lagging indicators but the experience of the last recession is instructive.

Unemployment was flat for the first half of 1990 and began to fall in the middle of the year, the point when GDP began to decline. So the economy is holding up, despite weakness in housing and financial services. Will this change?

Sir Alan Budd, former government chief economic adviser, likened the experience in 1990 to a cartoon character running off a cliff and suddenly finding there was no means of support. Could history repeat itself?

The three recessions Britain suffered between 1973 and 1992 had a common characteristic. In each case interest rates were raised sharply to curb inflation and, in the case of the 1974-75 and 1990-92 recessions, to end an unsustainable boom. By the time rates were cut, the economy was already in recession and it was too late.

This time interest rates are on the way down at a time when the economy is still growing. But could it be that the squeeze the credit crisis is imposing on the economy will not only make the Bank’s efforts futile but will snuff the life out of the economy?

Do we have the private sector — the banks and the financial markets — in effect running monetary policy? It is a point of view, and certainly the pass-through from rate cuts by the Bank is more muted than usual because lenders are rebuilding their profit margins.

There still is an effect, however, in the sense that interest rates available to borrowers are lower than they would be in the absence of Bank action. The lower pound, highlighted by exporters as helping them significantly, is also an important transmission mechanism.

In the end, though, modern economies run on credit and if credit suddenly dried up, they would stop growing. Fortunately, and contrary to some of the things you may have read and heard, that is not happening. Credit is certainly tougher to get hold of for some borrowers and will be for some time, but there is still plenty around.

Figures from the Bank last week showed just how much. The broadest measure of lending in the economy, M4 lending, rose £16.4 billion last month, up 12% on a year earlier. Another measure, excluding the effects of securitisations, rose by £19.3 billion for a 13.7% growth rate. M4 itself, the “broad” money supply, is growing by 12.3%.

These are the kind of numbers that have monetarists worrying about boom, not bust. They do not suggest the lending taps have been turned off. We should not ignore the challenges the economy faces. It would be good to see one group of “investors”, commodity speculators, take a real bath rather than the mild soaking of recent days. A big fall in the oil price would be of considerable help. But this is not the time to dust off the depression and recession primers.

PS: The release of figures showing a rise in inflation and the annual shake-up in the index “shopping basket” — muffins and smoothies in, CD singles and 35mm film out — brought a strange response. I swear I heard a woman on breakfast television say the consumer prices index (CPI) gives iPods as big a weight as food and fuel. Some claim “true” inflation is in double figures.

So let us set the record straight. The CPI, currently rising by 2.5%, has its faults. It does not, however, assume that people buy a new music player or flat-screen television every time they go to the supermarket. The combined weighting of “audiovisual and related products” in the CPI is tiny, 27 parts in a thousand.

The big expenditures that dominate the CPI are the necessities: transport, 152 parts in a thousand, food, drink and tobacco, 151, and household fuel, water and related bills, 115. It incorporates the big increases coming through, such as a 44% rise in fuel oil for central heating and an 18% increase in dairy products.

The CPI is thought to exclude housing but that is not so; rents are included, though not owner-occupied housing. That is included in the retail prices index (RPI), which puts inflation at 4.1%. This, and not double figures, is close to where most people think inflation is — 3.9% according to the Bank’s latest attitudes survey.

As for the future, people think inflation will be 3.3% over the next 12 months, halfway between current readings on the two measures. That seems reasonable, though it is too high for comfort for the Bank.

It will not, however, prevent the monetary policy committee, which voted 7-2 to leave Bank rate on hold this month, cutting again soon.

From The Sunday Times, March 23 2008