U.K. Recovery Just a Mirage

A recent comment on my blog suggested that perhaps there was not much to write about, as the UK economy appears to be recovering. Bearing in mind that such stories are now appearing in the press, it is not surprising to see that this point of view is gaining some traction. For example, we have this from the Telegraph, reporting on the National Institute for Economic and Social Research (NIESR):

NIESR’s optimism was echoed by the Royal Institute of Chartered Surveyors (RICS), which expects house prices to rise this year, in a startling reversal of its forecast that prices would plunge 10pc to 15pc in 2009.

A slew of positive economic data and an upbeat trading update from Carpetright – often seen as a bellwether for the economy – prompted analysts to predict the UK could emerge from the recession as early as the third quarter.

From David Wighton, of the Times, we have the following:

Still more convincing, the purchasing managers’ survey of services, the most timely and respected gauge of the economy’s most vital sector, shows expansion for a third month, and at the fastest pace since February last year.

The equivalent manufacturing survey shows that industry is rebounding too, and the fightback is affirmed by official data, with the biggest monthly output jump since October 2007.

Markets seem convinced — the FTSE 100 is up by a third from its lows plumbed at the start of March.

It all appears to be compelling evidence of recovery, does it not?

The truth is that we are witnessing a mirage. My first article for my blog was entitled 'A Funny View of Wealth', and I return in this post to the theme in this (very long) essay. The essay was written before the economic crisis struck in full force and, in the essay, I tried to find the apparent source of wealth in the UK, but found that there was no explanation except for a massive expansion in credit. Output of commodities were in decline, manufacturing output had remained static for many years, and export of services provided no explanation for the massive 'growth' that had apparently taken place in the economy. The remaining explanation was that the UK's growth had been built upon borrowing, and in particular borrowing from overseas.

We can now fast forward two years in time, and I can ask the same questions. Exactly what is the source of the current 'recovery'? Which sector is producing the growth in wealth creation to justify the 'recovery'. Let's start with manufacturing:

click to enlarge

The chart above is the production index from the Office of National Statistics (ONS). It seems that, even with an uptick now, we are now producing significantly less than ten years ago. This is what the index of production covers:

The Index of Production (IoP) measures the volume of production of the manufacturing, mining and quarrying, and energy supply industries, which covered 17.2 per cent of the UK economy in 2005.

How the word 'recovery' might be applied to this is very puzzling. With regards to productivity, the picture is as bad, with this from the ONS.



As can be seen here, the UK is not in the midst of any kind of productivity miracle that might explain the sudden recovery.

The other potential source of real growth in an economy is in the exports of services. In the essay at the start of the blog, it was apparent that financial services were at the heart of the growth in services export, and the decline of the sector has been reflected in recent services export figures, with a negative trend appearing in the figures (raw data taken from the ONS here - series IKBB & IKBC & IKBD). Curiously, 2008 did see a moment of increase in the positive balance (in part as a result of an expansion in financial services exports - see data here), but Quarter 1 2009 reversed this. Overall, the picture is one of a continuing positive balance in the export of services, but still with nothing that might offer an explanation of the current 'recovery'. On the latest figures from the ONS, which takes us to Quarter 1 of 2009, there is no explanation for the recovery.

Then there is the overall trade balance, which has seen a shrinking of the deficit, but still an ongoing deficit. This from TradingEconomics:

The trade deficit continues, despite a substantial devaluation of the £GB since the crisis began, such as the decline against the $US (apologies for the poor chart). Devaluation has the effect, for example, of reducing the purchasing power of consumers within a country, and is therefore a real reduction in wealth of the individuals whose income is derived in the currency.



However, it is when we see the current account that the scale of the problem becomes really apparent, with the following chart from TradingEconomics:


If taken together, what we are seeing here is no growth in output from manufacturing that might explain a 'recovery', no growth in the export of services, and an ongoing current account deficit. It is hardly a picture of a 'recovery'. To this happy picture of 'recovery', we can add unemployment, with this from the ONS:


It is worth thinking about the underlying meaning in this chart. The proportion of working age people in employment is falling off a cliff. If people are not working, where is the output in the economy coming from? We know that there is no productivity miracle, so how exactly can an ongoing decline in working people explain a recovery? Where can real increases in output in the economy come from except from either a growth in productivity or a growth of the numbers in the workforce actually in work?

For regular readers, they will be aware of my cynicism about what GDP figures actually show, as they include activity from debt based consumption (see here for a full explanation). However, even this indicator, which potentially massively overstates the positive in an economy, looks like this:


So exactly what is the source of this recovery? Here is a summary of where we are at:

1. There is no productivity improvement but a decline
2. The number of workers in the workforce is in rapid decline
3. Production is below the levels of 1998
4. The trade balance of goods and services is negative, the trade in services remains positive but with no growth, and the current account balance is negative. On balance, we are still consuming more than we produce.
5. GDP growth, a poor measure that exaggerates the positive, is still negative. Even if it were to move to the positive, how much of the activity recorded comes from growth in debt?

Altogether, this simply shows that there is no sustainable recovery. A shrinking UK workforce is still consuming more than it produces, and productivity and output are still in negative territory.

So where exactly is the recovery? The indicators given as evidence of recovery are the slight uptick in manufacturing, which I have already dealt with, house price recovery, and the stock market recovery. The recovery proposed appears to the return to price inflation of two asset classes, but with no underlying economic justification for these that might be seen as sustainable.

So where is this 'recovery' coming from? Once again, I return to the theme outlined in 'A Funny View of Wealth'. The only real reason for any signs of 'recovery' is that there is yet another increase in debt. The only real difference this time is that the source of the borrowing is primarily the government, and that borrowing is expanding at a record rate. Again, from the ONS:



And how is the government funding that borrowing? By the Bank of England printing money, which is then used to purchase gilts (UK government bonds). The Bank of England has just announced yet another expansion of the so called 'quantitative easing' (QE - printing money) programme, which is primarily being used to purchase government debt. I have previously shown that the QE purchase of debt is propping up the UK bond market, and that it is the monetization of government debt.

What we are looking at is simply more delusion, more hiding from the underlying dire state of the UK economy. The 'recovery' is founded on printing money and more debt. I will quote myself from an earlier blog post, which in turn quoted an even earlier blog post. It is shocking that nothing has actually changed:

Quite simply, aside from the fact that a failure to fund the deficit would be catastrophic, what kind of 'recovery' is it, if it is being financed by borrowing 13% of GDP?

A long time ago, I made an analogy with a household to explain the absurdity of this notion. A household has been racking up huge debts due to too much expenditure on the 'good things in life', but continues spending. All the time the family's debt is increasing, and then the bad news comes. The wife's job is under threat, and the husband's working hours are being reduced. Their income is declining, but the cost and size of the debt is increasing. They are in deep financial trouble, and are borrowing more and more money in order to keep their lifestyle and also to make payments on previous debt.

It looks like the household is in crisis, and they will soon go bankrupt if they continue their profligate spending. Fortunately, so it seems to our irresponsible family, a visitor comes to their house from 'Dodgy Loan Corporation' and offers them a further and much bigger new loan. They look at the figures, and it appears that, if they accept the loan, the family will be able to continue to live the same lifestyle as they had before. A massive weight lifts off their shoulders, and they live happily ever after.....

We can all (I hope) see the problem in the happy ending. I have not mentioned the prospects for the family's income increasing in the future, and without a massive increase in income, bankruptcy will just be delayed. Sadly, for the family, there is no identifiable prospect of such a massive increase in income in the future, and they are just hoping that 'something will turn up'.

I keep wondering how long this can continue. How long can we delude ourselves that all will be ok if we just keep on borrowing more and more, even as our income declines. I keep on asking myself, 'when will we wake up to reality?'

Comments

[Clive Corcoran:]

The Bank of England has effectively cornered the gilts market.
Some cynics of my acquaintance are even asking whether this system of completing the daisy chain between the Bank's printing press and the funding of the public finances needs a new moniker as Ponzi scheme doesn't quite fit the bill.

Aug 07 04:43 AM

[chap08:]

I don't see too many differences between the UK and US. Largely it is the same story in terms of how we got here and what people are doing about it. Pretty much any problem the US has, the UK has too. The differences mostly play in favor of the US e.g. labor market flexibility, productivity and reserve currency status. Also, recovery in the UK and the rest of the world will be closely tied to the shape of any recovery in the US. So, projection for the UK = project the US and make it a bit worse.

Aug 07 06:54 AM

[jimboy:]

An excellent article which dissects the UK recovery thesis with the skill of a surgeon. Remarkably though the feeling that the "worst is behind us" is rapidly gaining credence in the UK, as if all the excesses of the boom (when household debt trebled in ten years) have been sorted out just because house prices have ticked up a bit.
I am British and find the complacency and ignorance of the mainstream media embarrassing. A couple of examples:
- QE is accepted uncritically as a way of "pumping" in money to "support" the economy with no real debate about its wisdom or acknowledgement of Clive's point above.
- Quite obviously the narrow inflation-targeting policy of the government and its Monetary Policy Committee has been a catastrophic failure but noone has discussed changing it (e.g. to include targeting a wider range of indicators such as asset prices and debt)
- Equally obviously public spending, employment and wages have to be slashed to bring them back into line with what the country can afford. The Conservative opposition has hinted at the need for this but it's all a bit timid.
- it is commonly accepted that "greedy bankers" caused the crisis with very little discussion of the deeper monetary policy errors.
- a continuing obsession with house prices as if rising property prices are the sole basis of prosperity.
This is why I spend a lot of time on American sites because at least these issues get aired and there are people who seem to get the bigger picture.

Aug 07 07:22 AM

[Moon Kil Woong:]

QE does wonderful things to an economy. It supports a falling economy right up until it destroys it for decades. Fortunate for Japan they avoided the worst aftermath, a thoroughly discredited currency, inability top borrow overseas, and fiscal seppuku. Others that follow in their footseps are not likely to be as fortunate.

In the meantime, we also get to see economies undergoing QE contort out of all semblance of reality as they disconnect themselves from reality and cleave to some new mystical government guided mechanism of false productivity and contrived wealth and redistribution. I think in order to understand that we should give a call to old USSR comrades as economic signals become increasingly crossed.

Aug 07 08:34 AM

[Leftfield:]

Little need be changed to plug this analysis into the American picture.
Great point, simply put, "GDP growth, a poor measure that accentuates the positive."
It troubles me that amongst the many reasons, great and small, that have landed us where we are is that dishonesty has increased with the rise of "professionals." Why are government statistics and financial methods ever-phonier seemingly without a word from accountants? Like teachers who allow a decrepit, destructive and wasteful unionized system to dumb our kids ever-downward at the highest cost in the world, like professors who bend findings to the whims of their benefactors, accountants are happy to have metastasizing government that needs their inputs to navigate ever-proliferating edicts and rules. Honesty not required.
I needn't mention lawyers.
Seems you have the same "green shoots" press and public. We in the US are not the only ones with an embarrassing and dangerously deluded public discussion.

Aug 07 08:46 AM

[phil from E...:]

Now compare this to what Britain did after WW1. The US was the lender then, now it is presumably China. The US was the emerging manufacturing power then, now it is China. This is a replay of the run up to 1929. Hopefully the "best and the brightest" have this figured out and the exit strategy.

Keynes said "in the long run we are all dead". At least he is.

Aug 07 06:08 PM

[Cynicus Eco...:]

Thank you for the comments

Aug 07 07:35 PM

[Fighting Yoda:]

Peter Schiff for Senate:
www.schiffforsenate.co...

Aug 07 07:38 PM

[Cynicus Eco...:]

Sorry, the above comment was unintentionally submitted. What I meant so say was thank you for all of the thoughtful comments. In particular, with regards to QE and Ponzi schemes, I agree that we are witnessing something similar but slightly different. Perhaps one day QE will be called a 'Bernanke' scheme?

With regards to the similarities of the US and UK mentioned by Chap08, I could not agree more. I was tempted to do a similar piece for the US economy, but chose the UK as many of my blog readers are from the UK. However, the story is very similar for both countries. The point about the reserve status is interesting, as I think that, rather than a positive, it multiplies the dangers for the US. It allows even greater problems to develop. More could be said on that subject, but needs more consideration than can be put in a single short comment.

Above all, it is encouraging to see that the informed readers of SA are cynical about QE, despite so much support for this policy in the press. It is worrying to see how it is spun, and how this has created a broad acceptance of the policy.

Aug 07 07:48 PM

[Deepv:]

You doom and gloomers are smoking c'pipe. You'd think all the smart people were bombed off the earth via plague. The wealth in the economiy consists of:

1) people = talent
2) buildings and land
3) total factory productivity

I submit NOTHING zilch has changed in this equation. All the debt we (and the UK) have is held by a creditor. It is a zero some game. There is no NET debt. Just a creditor and a debtor. We are on the very of a huge boom in emerging markets right under your doom noses. Yes, the US is permenamently losinng relevancy (much like the UK from 1900 - can you believe UK was once 50% global market?). But the world is going to move forward and caitalism has been exporteed and won out. Buy stocks when discount rate is near zero or admit you don't understand maths. Deep

Aug 07 09:38 PM

[Hillsfar:]

A bit of the same is happening in the United States.

It's just more obfuscated because our country is so much larger, people the world over are still buying larger quantities of farmed and manufactured goods and services from the United States, and a larger locomotive will naturally have more momentum.

But if I were Soros, I'd certainly be shorting the pound now and the dollar later.

Aug 08 04:59 AM

[Wisdom vs. ...:]

somebody explain inflation to deepv, please, since he does not understand it yet

Aug 08 08:15 PM

[Deepv:]

stocks are great hedge vs inflation wisdom. go chart the S&P since 1930 to see. in a going concern system, being bearish on stocks is to be bullish on printed fiat in long run. makes zero sense.

Aug 10 01:19 PM

[Deepv:]

stocks are great hedge vs inflation wisdom. go chart the S&P since 1930 to see. in a going concern system, being bearish on stocks is to be bullish on printed fiat in long run. makes zero sense.

Aug 10 01:19 PM