Is U.K. Headed for an Even Worse Great Depression? (Part 2 of 3)

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IMF Revises UK GDP Forecast. Again.

The IMF has revised its GDP forecast for the UK economy for 2009 from -1.5% (November 2008) to -2.8%, and the forecast for 2010 is now +0.2%. The forecast still seems overly optimistic in the light of UK fourth quarter GDP contraction of -1.5%. The IMF has a good track record of being WRONG, with overly optimistic forecasts that are continuously revised lower.

The Institute of Fiscal Studies Talking Sense

Finally, reports from mainstream institutions are starting to emerge that reflect the crash in the UK economy that will hit hard for many years after the recession ends. The IFS in a recent press release states :

Treasury figures suggest that the credit crunch will cost the Exchequer an ongoing 3.5% of national income (or a little over £50 billion a year in today’s terms) in lost tax revenue and additional social security spending. This excludes any long-term impact from the Government’s interventions in the financial sector, although even a large one-off loss adding to public sector debt should increase the ongoing cost in extra borrowing relatively modestly compared to the impact already reflected in current Treasury forecasts.

In the PBR the Treasury signaled spending cuts and tax increases starting in 2010–11 and raising 2.6% of national income (£38 billion a year) by 2015– 16. If the public finances evolve as the Treasury hopes, this tightening would have to remain in place until the early 2030s before debt returns below the ceiling of 40% of national income Gordon Brown set as one of his two fiscal rules in 1997. So there is no prospect of a Government being able to readopt these rules any time soon. We hope they will be reformed in any event.

Unfortunately, the Green Budget does not expect tax revenues to grow as strongly as the Treasury hopes over the next few years. In the absence of any additional spending cuts or tax increases, we forecast that the Treasury would have to borrow 1.5% of national income more in 2015–16 than it predicted at PBR time – even if the economy performs no worse than expected in the PBR. This would take public sector net debt above 60% of national income, from where it would decline only very gradually over subsequent decades.

The key point here is that the IFS states that the UK will run a 1.5% budget deficit until 2016, and UK debt (PSND) is not expected to return to below the ceiling of 40% of GDP until 2030, from a rate above 60%. This therefore supports my scenario that after the recession the UK will be heading for many, many years of stagflation, i.e. low economic growth plus high inflation.

Confederation of British Industry Forecasts 3.3% 2009 Contraction

The CBI -

The UK's leading business group predicts the recession, which began in the third quarter of 2008, will last throughout 2009. The economy is expected to contract by 3.3 per cent and unemployment will reach close to 2.9 million by the end of the year. After six quarters of negative growth, the economy is expected to stabilise early next year with the recovery building throughout 2010.

The CBI predicts the economy will contract by a cumulative 4.5 per cent over the six quarters of negative growth. GDP growth for 2009 has been revised down from -1.7 per cent in November to -3.3 percent. In 2010, GDP growth is expected to be 0.0 per cent.

The impact of the recession and the fiscal stimulus will take a toll on the public finances with net borrowing for 2009/10 expected to reach £149 billion and £168 billion in 2010/11, which represent 10.6 per cent and 11.8 percent of GDP respectively.

The CBI is clearly following hot on the heels of the IMF in doubling its rate of contraction for the UK economy from November's -1.7% to now -3.3%. The key point here is that the CBI now recognises that government borrowing is set to soar for the tax years 2009-10 and 2010-11 totaling £317 billion, up £100 billion and now virtually identical to my forecast of November 2008 of £314 billion. Did the CBI read my forecast ?

UK Money Supply

One of the key driving forces of the 1930's Great Depression was the collapse in the money supply of the United States that fell by 25% and was tracked lower by GDP. However, that lesson appears to have been learned, given the amount of Quantitative easing taken by both the US and UK governments. They embrace the money printing presses in an attempt to stop deflation from taking hold and thus are igniting another Great Depression. Yes, rampant growth in the money supply is inflationary, however the money supply adjusted for the velocity of money paints a truer picture a the below graph illustrates

click to enlarge

UK Money supply M4 (blue) has risen sharply from the 10% targeted low of mid 2008 to the current level of 16.6%, on face value this is highly inflationary and has been taken by many economists and market commentators to suggest much higher forward inflation. However the money supply adjusted for the velocity of money, which takes into account the state of the economy as a consequence of the credit freeze, tells a completely different story. The UK economy is now in extreme real monetary deflation of approaching -15%. The leading indicator of the implied money supply is suggesting that recent deep interest rate cuts will lift future money supply growth out of extreme deflation, however, it will still be far from supporting the levels north of 15% which accurately forecast forward inflation during 2008.

Therefore, the primary objective of the UK government is to prevent a deflationary downward spiral from taking hold at ANY COST. The Bank of England has already been instructed to ignore inflation and focus wholly on preventing DEFLATION. The price for this will be for eventually higher future inflation IF they succeed in preventing the deflationary downward spiral that IF they fail WILL result in a another GREAT DEPRESSION. For more on the impact of economic deflation, download the world's foremost expert on and proponent of the deflationary scenario, Robert Prechter's FREE 60-page Deflation Survival eBook.

UK Inflation

The Bank of England's quarterly inflation report forecast UK inflation of just 0.5% in 2 years time, with the UK economy now forecast to have fallen by GDP 4% by the middle of this year. It was not so many months ago that the Bank of England was forecasting growth of 2% for 2009.

Bank Governor Mervyn King implied by his accompanying statement that he does not have a clue what he is doing, as the UK economy under his and Gordon Brown's collective stewardship continues to fall off the edge of a cliff. The Bank of England Governor stated :

“The United Kingdom economy is in deep recession. The length and depth of the recession will depend to a significant extent on developments in the rest of the world, where a severe economic downturn has taken hold.”

• The economy faces its deepest recession since the post-war years of 1945 and 1946, and its worst peace­time decline since 1931.
• The Bank is likely to reduce interest rates further, perhaps to as low as zero, in an attempt to prevent the downturn becoming worse than the depression in the 1930s.
  It will resort to new drastic measures to pump extra cash into the economy as soon as this week.
• Unemployment – which hit 1.97 million Monday – will rise further and house prices will continue to fall in the coming months.

My commentary during the summer months of 2008 seems to have been proven accurate in that the BoE MPC at those monthly meetings remained paralysed by the fear of inflation and more or less sat sipping tea and conversing about the weather whilst the economy continued to burn towards the fourth quarter crash.

What is the Government's Solution?

Quantative Easing, aka Printing Money, the consequences of which are that Britain is at increased risk of bankruptcy as I first warned of in April 2008 following the first print run of £50 billion by the Bank of England. I reiterated on a near monthly basis since (archive), with the most recent article (UK Interest Rates Crash to 1% New Record Low) updating to the current position of Britain's path towards bankruptcy.

The British Pound responded to the Bank of England's report by resuming its bear market after the correctly forecast bounce from £/$1.37 to above £/$ 1.45 and now again on route towards parity to the U.S. Dollar. (21st Jan 09 - British Pound Panic Selling, Counting Down to Bankrupt Britain).

FSA - Who Should Regulate the Regulator?

To illustrate the point in how wide the gap is between competent regulation of the UK banking system and how it is actually being regulated by the FSA, (not just before the credit crisis broke in August 2007, nor in the immediate aftermath which witnessed the run on Northern Rock Bank (NHRKF.PK), but to this very day) - some 18 months on we witnessed the resignation of Sir James Crosby, Gordon Brown's own appointment as the Deputy Chairman of the FSA. This was due to allegations that during his tenure as the head of HBOS (HBOOF.PK) (Halifax), he sacked Paul Moore because of the alleged complaints he had made about the banks' risk taking that had not been properly minuted at HBOS board meetings.

Deflation of 2009 Will Eventually Turn to Inflation

My earlier analysis of the UK inflation concluded that the UK is heading for real deflation during 2009, with the RPI inflation measure expected to go negative by mid 2009 by targeting -1.2%. The expectations are for similar deflation across the world, as deficit spending stimulus packages cannot hope to compete against the loss of asset values, which are in the order of ten times the amount of planned stimulus. The analysis also concluded that the immediate risks to the forecast are to the downside, i.e. prices spiking lower than expected as evident by December's sharp drop.

This therefore implies further stimulus packages far beyond that which have been committed to date, with all of the associated consequences of collapsing currencies under the weight of growing deficits and liabilities. This sets the scene for higher future inflation, as the deflationary impact of collapse in crude oil during the second half of 2008 starts to leave the inflation indices during the second half of 2009. Thereafter the deflationary forces of contracting economies will compete with the inflationary forces of money printing and rising commodity prices. Already sterling's devaluation is hitting food prices, as the price of imports rises and domestic food stuffs such as meat are increasingly being exported to mainland Europe. This is due to increased demand on lower Euro pricing and therefore reduced local supply is contributing to price rises.

UK Unemployment

UK unemployment shot up by 48,000 for November 08 data to 1.97 million, and remains on target to bust above 2 million on release of data for December 2008. The unemployment claimant count soared by 11% for January to 1.28 million, up a shocking 129,000 on the month and confirming that the pace of unemployment is accelerating as the economy fell over the cliff during the fourth quarter.

My original UK unemployment forecast, based on July 08 data, is for unemployment to rise to just above 2.5 million by April 2010. However the UK economy continues to deteriorate at an alarming rate, with projections of a severe recession of more than 4% GDP contraction. This implies that the UK is heading for an unemployment rate that could pass above 3,000,000. The jump in claimant count alone for Dec 08 and Jan 09 totaling 226k implies sharply higher unemployment for December and January. This despite the fact that the unemployment statistics are heavily manipulated to under report true unemployment, which would be nearly 6 million higher if all those of working age (16 to 64) were included in the data.

The real number of unemployed in the UK now stands at 7.86 million for November. As the below graphs illustrate, the actual dip in total inactive is due to net migration, as eastern european workers are apparently returning home in the face of increasing difficulties in the UK labour market.

Gordon Brown Bankrupting Britain to Win the Next Election

The in-depth analysis of November 2008 illustrated why Gordon Brown is well on the route towards bankrupting Britain, as the liabilities by 2012 will exceed £3.5 trillion from £1.5 trillion at the end of 2007. The prime consideration for the Prime Minister is to win the next election at clearly ANY COST.

The above liabilities do NOT include the £5 trillion of additional liabilities should the government be forced to nationalise virtually the whole banking sector. However, again, people need to realise that the future gets discounted in the present, which is why the Bank of England, Treasury and Government policy makers do not comprehend that they cannot embark on the route towards £3.5 trillion plus liabilities without the market reacting. They would do so by selling out of the currency long before the country arrives at the debt destination. The effect of this is to make the current crisis far worse, as the market seeks to discount the over 80% of the £5 trillion banking sector debt, which is denominated in foreign currencies. Therefore, the facility to inflate out of debt through "Quantitative Easing" does not work, as the repayments have to be made in foreign currencies against which the country's debt burden rises as the currency falls and therefore puts Britain's banks under greater pressure. The impact on the economy is deflationary whilst import prices rise, thus suggesting a stagflationary outlook or worse.

On top of ever expanding public liabilities that at the end of 2008 stood at an estimated £2 trillion, there is also the private sector debt of £2 trillion weighing down on the economy and sterling.

Time is running out for the government, forget 2011, 2010, even mid 2009, a currency collapse would bring the debt crisis to a head within a matter of days. Just as occurred with Iceland, as it did not take 3 or 4 years for Iceland to collapse into hyper-inflation, it took 3 or 4 days! As I warned of in the article Iceland Going Bankrupt?, and subsequently warned that all of the conditions that led to the bankruptcy of Iceland are present in the UK.

Workers In revolt, What's the Answer ?

In Britain, workers have been in revolt against foreign workers shipped over from mainland Europe when there exists a mass of domestic unemployed labour. Britain's free market attitude towards the labour market, works well during the boom times and in a level playing field, however what exists in much of Europe is not a level playing field with labour restrictions and subsidies increasingly becoming the norm. Take steel workers, in Yorkshire, Corus has announced 8,700 job losses, whilst in Holland 6,500 Corus steel workers receive 70% of their pay from the government. Of course this is one of the benefits of being inside the EURO which allows one to get away with such action without paying the price in terms of currency collapse.

Whilst this is a help in the short-term, as the 1970's and 1980's illustrated, supporting loss making industries in the long-run is the sure fire way towards economic stagflation. Therefore, whilst there is undoubtedly much pain in store amidst a global economic downturn, there is no long-term advantage towards subsidising zombie industries for which demand is collapsing. It would be better for the government to pay for the re-training of workers for new technologies and industries that will conqueror the world coming out of recession then keep them stuck in industries in terminal demise.

Bailout of the Auto Industry

Conservatives Whistling in the Wind - The conservative party as embodied by Kenneth Clarke seems to understand the problem even less than the Labour government by calling for the underwriting of car loans to support the UK auto industry. The flaw in the conservatives' argument is that 86% of cars bought in the UK are imported, therefore such a proposed bailout would for every £1 underwritten, 86p would go to supporting foreign manufacturers and therefore the conservatives would be bailing out foreign auto manufacturers, as any clauses in favour of domestic manufacturers would risk protectionism retaliation.

Collapse of the Euro?

Many commentators are contemplating the death of the Euro due to countries within the Euro zone pulling in opposite directions, such as Ambrose Evans-Pritchard, who has apparently declared war on the Euro. I would happen to guess that the vast majority of the Euro doom commentators FAIL to understand or conveniently ignore that had countries such as Ireland been outside of the Euro then they would already have collapsed Iceland style. Therefore, the current crisis has in effect strengthened the Euro domestically, regardless of what the rate does against the Dollar and other currencies. Domestically, there is fear amongst many of the smaller countries within the Euro of what would happen to them IF they were outside the Euro and therefore the risks of a Euro collapse are greatly over exaggerated. On the contrary, countries such as Iceland who were vehemently anti joining Euro will be lining up to join the Euro as soon as their economy has stabalised, as the risks of being outside the Euro are infinitely greater than being within the Euro.

Right across Europe, Euro Skeptics have been silenced by the near collapse of the banking system that emanated like a contagion from the United States, as every country's greedy banks sought to capitalise on the collatorised debt bubble. Clearly the Euro has been a life saver to many small countries and has allowed these countries to undertake extreme measures that would not have been possible outside of the Euro. From Ireland guaranteeing 100% of bank deposits, to Holland and many other countries subsidising wages up to a rate of 70% to keep workers employed. Unfortunately for Iceland, their own banks' extreme level of greed and the populations' fierce independence has led to the destruction of that economy.

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Comments

[Sicall:]

I wish someone could explain why "Deflation of 2009 Will Eventually Turn to Inflation".

The school i went to taught me that inflation was "too much money chasing too few goods" as far as i can see there will still be plenty of goods for sale even after the governments print money.

There is also the fact that unemployment is rising quickly. Surely for inflation we need employment to fall.



I

Feb 18 07:57 PM

[User 362916:]

Britain is well and truly screwed. The unemployment figures, like all the other government figures, are flawed and are much higher in reality when you consider all the wasters who claim to be students and spouses in married couples who are not included in the bent figures.

The industry which Britain used to have has been largely offshored to other countries and any remaining companies are almost all foreign-owned, for example Aviva which used to be Norwich Union. Consequently, a recovery from the economic depression we are heading into is virtually impossible. In reality, the pointless government bailouts will simply exaccerbate debt levels until bankruptcy is reached and people will be living on the streets on a large scale with widespread civil unrest. Moreover, all the immigrants who have leached off us will continue to take large amounts of cash out of the economy, hitting it further.

Prepare for the mother of all economic depressions.

Feb 23 06:29 PM