Sunday, June 07, 2009
The lending tap won't open for some time
Posted by David Smith at 09:00 AM
Category: Thoughts and responses


With so much going on in politics, the economy has benefited from being out of the spotlight. Not only have the figures been a lot stronger than expected but, until it hit some political turbulence of its own towards the end of last week, sterling had rallied significantly.

There are more green shoots around and a few brief points are worth making. First, while it would be premature to say the recession is over given that we will almost certainly see a further, though smaller, drop in gross domestic product in the current quarter a return to growth is in sight during the second half of the year.

Alistair Darling has had more to think about than his economic forecasts recently but, for all the mocking they received, there is a good chance that his budget predictions will turn out to be right.

Second, for all that excitable "Britain is a basket case" talk, and accepting this is a bad recession for everybody, the UK economy is doing no worse, and in some cases better, than others. Chris Williamson of Markit, which produces the monthly purchasing managers' surveys, thinks Britain will pull out of recession three months earlier than the eurozone, having suffered less than Europe in the first quarter.

Third, there is a risk that the economic bounce we will see later this year will not be sustained. Instead of a V-shaped recession, we could get a "W", in which there is another downward lurch before a sustained recovery, a "square-root" recovery (think of the sign from school), in which the initial bounce is followed by stagnation, or even a series of "W" episodes, bumping along the bottom.

Treasury officials fear that a strong upturn in the final months of this year, prompted by spending ahead of Vat being raised back to its normal level next year, could be followed by a relapse. Others warn that a combination of fiscal and monetary tightening, both of which will be necessary, will nip any recovery in the bud.

For me, one of the central questions is whether a pick-up in growth can be sustained even when bank lending remains weak. Amid the flurry of stronger news last week was some downbeat evidence from the Bank of England on lending.

Lending to households rose a modest 0.2% in April, the Bank said, and was up by 3.4% on a year earlier. But lending to nonfinancial companies fell by 0.9% and was a tiny 0.8% up on a year earlier.

This chimed with a survey from the Engineering Employers' Federation, which showed that 45% of firms had seen an increase in the cost of their finance and only 4% had seen an improvement in credit availability in the latest three months. It is a familiar story throughout business.

Charlie Bean, the Bank's deputy governor, buys into the story of a resumption in growth before the end of the year, but he also warned in a recent speech that bank lending was likely to remain subdued, at best, for some time.

"We are still some way from having banks feel sufficiently secure that they can lend normally, and from investors that have enough confidence in the banks to provide them with sufficient funds," he said.

The government's October banking measures were a straightforward rescue operation but its subsequent actions, particularly in January, have been intended to get lending flowing again. Quantitative easing, confirmed last week at 125 billion for now, was intended to boost lending and, while it is early days, is not doing so.

One reason may be the way it is operating. Mervyn King, governor of the Bank, professed last month not to be worried that many of the gilts sold to the Bank under the quantitative-easing programme have come from foreigners in March and April they sold 17.9 billion, more than twice those sold by UK institutions.

I think he should be concerned about this leakage in the policy. Michael Saunders of Citigroup believes the Bank could avoid this problem by deliberately purchasing gilts not typically owned by foreigners, those with more than 25 years to maturity.

So are we condemned to a dead-cat bounce, before we sink back into credit-starved stagnation, with a loss of banking capacity, over-cautious bankers and regulators locking the stable door long after the horse has bolted?

Maybe not. While people focused on the weakness of lending, Simon Ward, an economist with Henderson New Star, said the big story in the Bank's numbers was a 1% monthly rise in its adjusted measure of the money supply, M4. There are many factional debates in economics, but one current one is between the monetarists and the "creditists". Ward is in the former category and believes undue emphasis is being placed on the lending numbers.

He thinks the weakness of credit is in part explained by past economic weakness. That is certainly true of mortgages, where very weak mortgage approvals over the winter are being reflected in the hard lending data now. He also believes the pick-up in money-supply growth now, if sustained, will lead to a rise in credit growth. Those expecting an instant revival of bank lending, in other words, were putting the credit cart before the monetary horse.

Another possibility, given the traumas the banking system has been through, is that it is unrealistic to expect a genuine revival of lending. The banks are on official life support. You would not expect them to start running marathons again.

The International Monetary Fund (IMF), in its spring World Economic Outlook, produced a comprehensive analysis of past recoveries from recession. It showed, for example, that the more rapid the economic slide, the sharper the first year of recovery.

However, the IMF also pointed out that upturns from recessions that have their origins in financial crises tend to be "creditless". After these recessions it takes an average of seven quarters after gross domestic product has turned up before the growth of credit turns positive. Economies can grow, in other words, before credit does.

It may be that we will see something similar this time. Credit availability is a genuine problem for many firms but can the UK economy recover without a strong revival of credit growth? Probably it can.

It will mean that the economy in the recovery phase will be different, with spending financed out of income rather than borrowing and cash-generating businesses benefiting at the expense of credit-hungry ones. But that will be no bad thing.

PS: Talking of monetarists, the life of one of Britain's most distinguished, Sir Alan Walters, was celebrated last week in London. Walters, Margaret Thatcher's former personal economic adviser, who died earlier this year, was remembered with humour and affection.

John Blundell, director of the Institute of Economic Affairs, told the story of when, in 1981, after 364 economists had signed a letter attacking Thatcher's economic policies, at prime minister's question time the Labour leader Michael Foot asked her to name two economists who agreed with her. She replied, quick as a flash, naming Walters and Patrick Minford. But on the way back from the Commons, she is said to have told an aide: "It's a good job he didn't ask for three."

Walters used to play squash with Lord Layard, the LSE economist and Labour peer, another speaker, after which they would restore their calorie count with a Penguin bar; red for Layard and blue for Walters. On his 70th birthday Layard sent Walters 70 Penguins.

Most of all, as Thatcher recalled in comments read out on her behalf, he was always both intellectually rigorous and principled. As she put it: "His influence upon the economics of a generation has been immeasurable and we are the worse off today that he is not here to dispense his wise guidance at another time of economic crisis. I am sure that he would have a great deal to say about the direction in which we are going."

From The Sunday Times, June 7 2009