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

 |  Includes: EWU, FXB, FXE, GBB
by: Nadeem Walayat

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Protectionism on the Rise

One of the primary reasons why the 1929 crash resulted in the Great Depression was because of the rise of protectionism and the collapse of global trade.

Demonstrations and many heated discussions are taking place right across the developed world to protect workers from foreign labour. This is happening more so in countries with huge trade deficits that have effectively exported their manufacturing base abroad. For example, the United States and Great Britain, against these are countries that rely heavily on exports such as the fast developing countries of China, India and developed counties of Germany and Japan.

The arguments on both sides are convincing. My own personal take is that there should be a level playing field, if there is then everyone wins, if there is not then one side loses and the other side wins. Unfortunately we are NOT living in an era of a level playing field, this is particularly true where China and other asian countries are concerned. They seek to manipulate their currencies lower and thus interfere with the normal working of the market that will tend to correct trade imbalances. Clearly the zero interest rate policy is a response to this in that the western governments are in effect punishing countries that seek to manipulate their exchange rates and therefore are subsidising western budget deficits. However, the severe recession itself will go a long way to correcting unsustainable trade imbalances, as global trade collapses in the face of consumption meltdown.

UK Retail Sales

Headline retail sales bounced strongly in December, rising by 2% to an annualised 3.7%, as distressed retailers slashed margins on stock to avert bankruptcy amidst price cutting. This was in the wake of heavily discounted stock in the closing down sales of major retailers such as Woolworth's , Zavvi and Adams, that collectively account for some 50,000 jobs.

The expectation that over Christmas and January retail sales activity 'should' rise due to discounting materialised as our European and American cousins boosted retail sales volume by benefiting from the 30% crash in sterling. This means the already liberally advertised 20% discounts translated into a 50% discount for European shoppers, much as Britons benefited not so long ago from the cheap shopping trips to New York at an exchange rate north of £/$2.00.

However, as earlier analysis suggested, the fall in sterling will result in much higher street consumer prices during 2009 as those retailers that have not gone bust seek to replenish stocks at much higher prices during 2009. This confirms analysis that the January Sales for Britons may prove to be more illusionary than real as the fall in sterling has already soaked up corporate margins.

Retail Sales Trends

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The above graphs illustrate the strong rebound in retail sales, both headline and real retail sales trend that has moved out of deep deflation. However, as per the points mentioned earlier, it is highly unlikely retail sales volume will grow past the January sales season into February 2009 and March 2009, in the face of heavy job losses and retailers going bankrupt.

UK Housing Mortgage Market Lending Crash

The Council of Mortgage Lenders (CML) mortgage lending data released Tuesday shows a 49% crash in the number of mortgages granted to home buyers to just 516,000 which is the lowest number since the mid 1970's property crash. There were 32,000 house purchase loans in December, a decline of 5% from November and the lowest level since monthly records began in 2002.

Michael Coogan, CML director general, said:

"The shortage of mortgage funding and reduction in the number of active lenders has reshaped the mortgage landscape in the space of a year. This low level of transactions is insufficient for the functioning of an efficient market.

"Measures are now in place to seek to restore the flow of funding to the mortgage market, but this will take time to feed through. Further action may still be necessary to increase transactions, stabilise prices and restore confidence."

The CML data supports that of the British Bankers Association BBA, which saw the total amount outstanding contract from £524 billion to £496 billion.

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However, on a marginally brighter note, mortgage lending for house purchases rose from record lows during December 2008. This implies that the flood of tax payers' money, amounting to more than £1 trillion, coupled with angry arm twisting pressure from both the government and Bank of England on the part of wholly nationalised banks such as HBUST, Northern Pebble, Bradford & Bunglers and RBF, is starting to show at the very least a pause in the crash of the mortgage lending market. That helped to contribute towards a small bounce in the house prices for January 2009.

UK House Prices

A cheer went up amongst housing market participants across the land as UK house prices rose by nearly 1% in January 2009 as measured by the Halifax. However the government is throwing everything including the kitchen sink at the housing market to bring about a halt to the ongoing crash in nominal terms. The amount of money printed has mushroomed from the £50 billion of April 2008, which I warned was just the tip of the iceberg that would soon mushroom into the hundreds of billions. We are now in the process of leaving the hundreds of billions behind and moving into the trillions, sums that seriously risk the bankruptcy of Britain.

The mainstream media has jumped on the one month bounce to start contemplating the return of the housing bull market, i.e. The Times reports - The 10 towns where house prices will bounce back first -

"Property websites recorded a surge of activity in the first few weeks of this year, estate agents had a busier January than previous months and Halifax even reported a small rise in house prices."

UK Housing Market Affordability and Interest Rates

The February rate cut to 1% fulfills the forecast target for 2009 (4th Dec 08 - UK Interest Rates Forecast to Crash to 1% ) with the next stop a similar Zero Interest Rate Policy (ZIRP) as that adopted by the United States that have cut their interest rate to 0.25%. The deep cuts in interest rates whilst not wholly passed on have resulted in a fall in the economic rate of interest from over 6% in September 2008 to 3.54% today. This is having a positive impact on the affordability despite the recession and hence supportive of house prices in the short-term.

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UK House Price Forecast 2007 - 2012

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The rise in UK house prices during January 09 brings a pause to the house price crash that is now into its 18th month, as the above graph illustrates per the updated house price forecast that covers the trend into 2012, which projects for a total drop from peak to trough of 38%. However, as I have warned many times over the past 18 months, the government has in its power the ability to print money to bring nominal house price falls to standstill. This money printing is now quaintly termed as "Quantitative Easing" so as to hide the truth and mask the continuing crash in house prices that despite the opinion of the mainstream press by the likes of Anatole Kaletsky and Ambrose Evans-Pritchard, HAS put Britain on the path towards bankruptcy. I explained this in the depth analysis of November 2008.

The Labour government's primary objective remains to maximise its chances of winning the next election. This will be to the detriment of future growth, as the consequences of printing money and the exploding debt burden risks a currency crash that at best means many years of stagflation and at worst hyperinflationary bankruptcy along the lines of the Weimar Republic and the most recent example of Iceland. This is evidenced by the following graph of UK house prices in terms of inflation, and our key trading partner the United States (U.S. Dollar), with a similar fall observed against the Euro.

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The above graphs clearly illustrate that the UK housing market has crashed by 25% (real terms) and over 40% (U.S. Dollar / Euro) which is having a severe impact on the UK economy as the real deflation of a 40% loss of value of house prices added to the more than 50% of that of stocks is tipping the UK economy towards economic depression. Therefore home buyers need to guard against the ILLUSION of stabilising house prices whilst the real terms crash in house prices continues.

UK House Prices Regional Trends

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While average house prices as of December 2008 are down 20%, in terms of price crash experience Northern Ireland tops the list at 35%, meanwhile Scotland continues to buck the trend by only registering a 6% drop to date.

Commercial Real Estate Bust of 2009

As the retailers go bust, financial institutions close or down sized, and corporations go bust, this is going to lead to a crash in the value of commercial real estate that has already begun.

UK Financial Sector

The financial sectors of all of the countries of the world are already in a deep depression and risk averse as remaining capital is protected in advance of further bad debts. This is leading to economic contraction across the whole globe against which governments are battling with ever larger stimulus packages. However Britain, with its extraordinarily large financial sector was always destined to suffer the most, more so then other large developed european countries such as France and Germany. Therefore, all the talk by Gordon Brown showed a great deal of bare faced cheek when he repeatedly stated how Britain was best positioned to face the global economic downturn, when in fact the exact opposite was true.

The United States' estimated bank losses are in the region of $2 trillion, UK bank losses are estimated to be $1 trillion, the only problem here is that the UK economy is only about 1/7th the size of the U.S., therefore British banks are exposing the UK tax payer to 3 times the losses as U.S. tax payers. This is the reason why sterling is being dumped, which as much of the debt is denominated in foreign currencies, has the effect of making matters worse because the value of the debt rises in terms of sterling. The Bank of England and the FSA have a lot to answer for - exactly what have they been doing in their ivory towers whilst the financial institutions were busy turning themselves into hollow husks?

International Trade in Meltdown

Global trade is collapsing and taking with it much of the hype that currency devaluation of 30% will boost the British economy. Yes we have had a 30% devaluation in sterling, but who is going to buy our goods? Who do we export to? World trade fell over the cliff during the past 4 months, with shocking figures coming through from right across the globe. This means that despite the 30% devaluation, 30% of the value of Great Britain PLC wiped out for NOTHING, as our exports WILL FALL during 2009, NOT RISE! ALL of the COST of devaluation with NONE of the GAINS, which illustrates the degree of incompetence right at the core of the institutions that are taking the decisions that are destroying Britain's long-term future. I fear far worse to come as Britain embarks on the next stage of currency devaluation that WILL lead to HIGH inflation. How high? Well that depends on how much the government wastes on trying to bolster bankrupt banks instead of letting them go bust and then restructuring what is left into a viable retail bank.

Global Economic Slump - Japan Back in Economic Depression

Today's recession is experiencing a global meltdown in international trade, where economies are falling off the edge of a cliff. What this means is that it is extremely difficult for a small economy such as Britain's to buck the trend.

Japan on Tuesday released truly shocking GDP data for the fourth quarter of 2008 - the Japanese economy contracted by 3.3%, which equates to an annualised rate of 13.2%, which is on par with a magnitude of contraction that is associated with an economic depression. All exporting countries are experiencing a crash in exports, which fell by 14% in the quarter, as western consumers stop buying and start saving. Japan's industrial plunged by nearly 10% in December 2008, down 20% on the year earlier.

Japan's government is expected to respond to the economic crisis by announcing a further stimulus package of more than $200 billion, as the government again attempts to fight against the deflationary spiral that has kept Japan in a depression for close to 20 years.

The collapse in the Japanese economy is ironic in a way, as Japan, similar to many other asian countries, was not exposed to U.S. subprime mortgage derivatives in the same degree as western banks. During 2008 this had given life to the argument of decoupling between the east and the West, however the exact opposite seems to be occurring with the asian exporting countries being hit harder than the consuming countries.

Global Trade Green Shoots?

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The Baltic Dry Index is a measure of global trade in terms of the price charged for chartering ships for the shipment of raw materials. Following the crash from a height of nearly 12,000 as the global economy fell off the edge of the cliff, the BDI has recently bounced. However as the chart shows, the degree of recovery is insignificant compared to the preceding collapse. For a positive development the BDI needs to build on the rally to date to start to imply that the world economy, in terms of international trade, is hitting bottom, which I would expect to be reflected in 3rd and 4th quarter GDP data. This would imply a short severe global recession. This is also a potentially bullish signal for industrial commodities that have been decimated during the crash in global trade.

UK Recession Projection / Forecast Conclusion

In the final analysis, the projected course of the recession over the next 2 years is illustrated by the below graph. The severe recession is expected to bottom at an annualised rate of -4.75% GDP in the fourth quarter of 2009 (small quarterly gain on the 3rd quarter), which will be followed by a recovery as the rate of annualised GDP contraction improves as government stimulus measures announced to date and deep interest rate cuts as well as future stimulus during 2009 kick into gear. The UK economic recovery is expected to continue into the fourth quarter of 2010 i.e. after the general election. The total recession from peak to trough is expected to see GDP contract by 6.3% and therefore this will be the worst recession since the 1930's Great Depression.

UK Recession Forecast 2009-2010Click to enlarge

Unfortunately for the Labour government, the economic cycle is completely out of sync with the election cycle, as the economy is not expected to emerge from this severe recession until AFTER the next election as 2010 1st quarter GDP is estimated to be at an annual rate of contraction of -3.9% (despite a quarterly gain). This therefore increases the probability of Labour losing the next election, as the state of the economy is nearly always the primary determining factor for the electorate. However the Labour government will do its utmost to battle against the recession, especially once GDP data shows contraction of more than 4% on annual basis. Therefore, the expectations are strong that the Labour government will sacrifice long-term growth for the short-term possibility of turning the economy around before the 2010 election. This also suggests that the 2010 recovery may not be able to take hold and therefore sets the scene for economic weakness during 2011-2012, perhaps suggesting a double dip recession.