An economy on the brink
Britain stands on the brink of one of the deepest recessions since the end of World War Two. Real GDP in the UK fell by its highest amount for eighteen years in the 3rd quarter of 2008 and this marks only the early stages of the downward slide. Most of the really bad economic news - such as the banking collapses and the carnage on the high street in the weeks before Christmas - happened in the final quarter.
2009 will be the first downturn that the vast majority of students will ever have experienced and for many, the direct consequences of a sharp fall in output, profits, jobs and spending will be clear to see.
Naturally for economics students and teachers, the fall out from the global credit crunch and financial crisis will be an incredibly interesting time - the era of the Great Stability has come abruptly to an end and all bets seem to be off regarding the extent and depth of the next stage of the economic cycle. Expect the word recession to be increasingly replaced by the word slump as the forthcoming year unfolds. Indeed the R word may be swapped for the D word if the contraction becomes embedded.
read more...»German Export Machine Starts Creaking
Germany has perennially run large trade surpluses with the rest of the world and used external demand as an important source of demand growth for their domestic industries. Germany ran a current account surplus of 7.6 per cent of gross domestic product in 2007.
Germany is the Euro Area’s biggest economy and in 2003 became the world’s biggest exporter. It has developed significant competitive advantages in industrial manufacturing and technology and in a world leader in mechanical engineering, holding about 20 percent of the global market. Just think of some of the world’s major high value-added manufacturing brands - DalmerChrysler, BMW, SAP, Siemens, Volkswagen, Adidas-Salomon and Porsche.
As our chart shows the annual rate of growth of exports has in recent years grown faster than her real GDP, the result has been a large and rising share of exports as a percentage of national income. Overseas sales have, to some extent, masked relatively weak consumer spending. Indeed real household consumption has been flat in real terms for the best part of two years.
But now the macroeconomic situation is changing.
read more...»Will sterling’s slide spook investors?
Hamish McRae has a thoughtful piece in his column in the Independent on the risk that sterling’s fall will make it harder for the UK government to finance their budget deficit. It is a good example of how, in the current climate, the effects of monetary policy and fiscal policy decisions are becoming blurred.
read more...»Falling investment as accelerator effect kicks in
Here is a fresh sign of the impact of the economic downturn. The real value of capital investment spending by businesses fell sharply in the 3rd quarter of 2008 - investment demand is now on a steep downward path as our chart illustrates.
This is evidence for what is known as the accelerator effect. The demand for capital goods such as new machinery, factories and technology is linked to the actual and expected rate of growth of final demand for a firm’s products. When market demand slows down or falls as it is across many sectors of the economy, so the amount of spare productive capacity increases and leads to a reduction in planned investment spending. Many businesses are scaling back their investment programmes or postponing capital projects because they have lowered their expectations of future demand, revenue steams and anticipated profits. Only this week we learned that an £88m investment at car maker Toyota’s Flintshire factory has been put on hold because of the economic downturn. Manufacturers, retailers and construction companies are all holding back from going ahead with projects - the lack of demand is the main factor.
Capital investment is a volatile component of aggregate demand and in total contributes around 16-18 per cent of the UK’s real national income in any given year. The drop in investment is a portent of difficult times to come and we can expect to see further cuts in capital spending (capex) as we move into 2009. The UK economy will suffer a deep recession next year and the availability of finance to fund capital spending is severely curtailed by the ongoing credit crunch
The result will be a reduction in demand for capital goods and related inputs - bad news for those industries whose own fortunes depend on a steady flow of capital projects from the business sector.
Can government investment spending help to fill some of an increasing void?
BBC: UK businesses cut back investment
Beta Currencies and PMD
Beta Currencies
The continued depreciation of sterling - most notably against the Euro - continues to dominate the economic headlines. One Euro now buys 95 pence and parity is much more likely than I thought when I wrote about the exchange rate last week.
For your exams remember that you need to have a clear handle on
Why the currency is falling (causation)
What the main demand and supply-side effects of this are (consequences)
The possible policy responses (intervention)
With the latter keep in mind that the government and the central bank does not have a target for the external value of the pound although they recognise that it plays an important role in influencing the components of aggregate demand (C+I+G+X-M and also changes in short run aggregate supply (SRAS) e.g. through movements in the prices of imported goods and services.
Another approach for critical analysis of the exchange rate’s fall is to use the acronym PMD
P - plusses - i.e. what are the main advantages of a fall in the currency?
M - minuses - what are the negative effects for the UK economy at this time and for different agents (businesses and consumers)
D - depends - “it depends on” is one of the best evaluation phrases you can use - sterling has fallen by more than 20 per cent (on a trade weighted basis) over the last year. This is a significant depreciation - but the effects DEPEND on many factors - here are a few:
Do exporters reduce their overseas prices or choose instead to keep prices the same and make a higher profit margin?
Do foreign consumers switch their demand to UK exports if and when our exports become more price competitive?
Will the negative real income effect of a global economic downturn offset the competitive advantage from having a lower exchange rate?
Will higher import prices help to prevent deflation in the UK next year?
Ambrose Evans-Pritchard has an article in the Telegraph today which argues that “Sterling fall is a life-saver for UK economy”
“Stephen Jen, currency chief at Morgan Stanley, said sterling is a “high-beta” currency, meaning that it is highly-geared to the global economic cycle. It shoots up during good times and plunges during bad times. It should return to health if and when the world emerges from economic winter.”
A related piece claims that the Sterling slide is the worst since 1931
“The pound has now fallen by 23pc against a basket of other currencies, according to figures from the Bank of England. The fall is sharper than the devaluations in 1992, after leaving the Exchange Rate Mechanism, 1976, when the International Monetary Fund was forced to intervene, and 1949, when a host of countries slumped against the dollar. The devaluation is only matched by the moment in 1931 when, under Ramsay MacDonald, the UK was forced to abandon the gold standard, plunging by more than 24pc against the dollar. The parallel is significant, since many economists have attributed the gold standard exit as one of the main reasons the UK enjoyed a relatively mild depression in the 1930s, while the US suffered mass unemployment and saw its economy shrink by a third.”
Global downturn leave costly empty vessels
The global shipping industry is associated with huge internal economies of scale and where demand is closely tied to the fortunes of industries such as iron ore, oil and coal but also to the world economic cycle. Things are looking grim for shipping operators who have bet hundreds of millions of dollars on expanding a fleet for which there is now substantially less demand.
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Economies of Scale - Giant Wind Farms
This BBC article on the granting of permission for a giant wind farm off the coast of North Wales might be a good example of the importance of economies of scale in making renewable sources of energy more cost efficient. And heading to the web site of the Gwynt y Môr Offshore Wind Farm accesses some resources on the potential costs and benefits of a scheme that might provide electricity for up to 500,000 homes. If construction goes to plan, the wind farm will start to produce power from 2012.
The rise of cyclical unemployment
Across the country and on a daily basis you will read of stories where workers are facing the threat or the reality of losing their jobs.
The economy is in recession and this brings about a fall in the aggregate demand for labour and a rise in cyclical unemployment. In many of the examples I have shown below, the root cause of the labour shedding is a decline in demand in a related industry – for example a cement factory that is finally shutting down because of the severity of the slump in new house-building. Or the employees at a local newspaper in Guernsey in the Channel Island affected by the steep drop in demand for traditional forms of media advertising.
read more...»Domino and Multiplier Effects
Paul Vallely has an in-depth report on the UK recession in today’s Independent. the front page alone is worth photocopying as a handout for its emphasis on the negative multiplier effects of small scale spending decisions that feed into lower demand, profits and jobs in supply-chain industries.
“It began with the banks. Then house prices began to tumble. In the months that followed, the shock waves spread, engulfing first high streets, then factories – and thousands of jobs. In this gripping account, Paul Vallely travels across Britain to meet the people whose lives – and livelihoods – have fallen victim to the domino effect that left a nation broken.”
Hamish McRae writes about the tax cutting pledges and their likely macroeconomic impact
What if the consumer abandons the economy?
Christmas could be the next victim of the credit crunch. The opening of the new Westfield shopping mall in west London - a project that has cost in excess of £1.5bn - may prove to have happened at an unfortunate time as households retrench their spending and look to rebuild their savings. But what would happen if consumption did decline at a significant rate? If consumers abandoned the economy and left more of the incremental demand to exports, government spending and investment?
The answer would be an almost guaranteed recession and a long one at that. This Wall Street Journal blog entry tracks what would have happened to GDP in the USA taking out the largest single component of aggregate demand.
“For years, consumers were the unflagging pillar of the U.S. economy, but all that changed in the third quarter. GDP would have been negative four times in that last four years if not for spending. At some 70% of GDP, consumer spending can be a major benefit, or as we’re seeing now, a major drag.”
A salient point and one we can relate to here in the UK since personal consumption as a share of national income climbed to a record high in 2007 and the first half of 2008. This is all changing although the UK national income statistics are yet to fully pick up the slowdown in household demand. News that employers predict a sharp rise in redundancies brought on by the current financial crisis will do little to lighten the prevailing mood music.
Chart
consumption_gdp.ppt
Roger Bootle on Keynes
““Everything you wanted to know about Keynes and were afraid to ask.” I think I can reduce Keynes’ view to seven essential propositions.2
Roger Bootle, senior economist from Capital Economics is on top form in this article in today’s Telegraph
Who are the Bank of England’s spies on the ground?
The Bank of England has a network of Regional Agents operating across the length and breadth of the UK. Think of the Regional Agents as a form of intelligence network designed to give the Bank of England a feel for what is really happening on the ground.
read more...»Why is the pound falling in value and does it matter?
Sterling in freefall; the pound takes a battering; Britain’s currency in a nosedive – the media are full of headlines about the abrupt depreciation in the value of the pound sterling in the global foreign exchange markets.
Sterling’s trade weighted price has dipped to its lowest level since October 1996. And the suddenness and severity of the depreciation has taken economists back to September 1992 when the pound made an unceremonious departure from the European exchange rate mechanism.
read more...»Negative equity - why is it a problem?
Negative equity occurs when the value of an asset falls below the outstanding debt left to pay on that asset. Term is most commonly used in connection with property prices and describes a situation where the market value of a house is less than the existing mortgage debt.
read more...»Collapse in new car sales - motor industry clutching at straws
The Society of Motor Manufacturers and Traders has reported a collapse in new car registrations as potential car buyers stay away due to a combination of low consumer confidence, tighter rules on credit and rising fuel and insurance costs. New car registrations in the UK fell 21.2% in the year to September to 330,295 units and the year-to-date volume is down 7.5% to 1,794,419 units.
read more...»Hamish McRae on the return of credit rationing
One of our most gifted business and financial communicators peers beyond the murky uncertainty of recent days to consider a world where those banks who survive the crisis are much more circumspect about how much they are prepared to lend.
“So people who are deemed bad risks, such as the self-employed and people in flashy professions, will find it harder to get a mortgage. Have a bad credit record and that will be a shut-out. First-time buyers will have to have saved for a 10 per cent deposit, or more. Small companies will find it more difficult to raise capital. Start-ups will find it harder to get going. Big companies, even profitable ones, will have to pare back their investment plans and cut their staff levels. Everything will slow down as a result.”
This is not a return to the dark ages although the prospects of a wholesale nationalisation of the bad debts of the banking system cannot totally be ruled out. But a world where credit is both harder to obtain and more expensive will come as a shock to the millions of consumers weaned on easy lending with minimum checks and balances applied. The danger is not that consumers have to become more prudent in their spending and borrowing habits, rather that small and medium sized businesses will have their ambitions curtailed by a new credit squeeze. There are already signs of a sharp downturn in planned investment spending.
A negative savings ratio - the first since 1958!
Much has been written about the financial squeeze facing millions of households in the UK. Disposable income has come under pressure from rising utility and food bills and an increase in the overall burden of tax. Just how steep this squeeze has been is shown by revised figures from the Statistics Commission on the household savings ratio – the percentage of disposable income that is saved rather than spent.
read more...»Millions fear being made redundant
A hat tip to my colleague Tom Allen for spotting this excellent macro article in the Guardian.
Jobless set to top two million as the UK economy heads for meltdown
As one company after another lays off its workers, Tim Webb, Heather Stewart and Nick Mathiason report on the crisis faced by struggling British households.
There is no doubt that millions of people have genuine fears of being made redundant. I read of one survey this week which put the figure at fifteen million. Concerns over job security are not always borne out by reality, but they deepen the sense of economic gloom and are likely to lead to further cutbacks in non-essential consumer spending.
Chart
unemployment_expectations.ppt
Some Good Radio Programmes
Last week’s Analysis was on sport and considered whether we should invest so much in sport. Our success in the Olympics suggests that the investment has paid off in one way at least. But is investment in the 2012 London Olympics worthwhile? Listen by clicking on this link
On the same evening, Investigation looked at the reasons for high oil prices. Listen to this here
Our Food, Our Future is a short series looking at food production and prices. Some of the recent programmes can be found on the website and there is a useful slide show here:
BBC radio 4 analysis has an archive of past programmes.
Cross elasticity: Demand for new aircraft
Over twenty airlines have gone bust since the price of aviation fuel started to climb and the turbulence in the global aviation market is likely to lead to a fall in demand for new aircraft according to a report in today’s Times.
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Manufacturing gets a boost from UK government investment
British manufacturing industry perennially appears to move from one recessionary period to another. But although the sector as a whole has shrunk as a share of GDP and employment, we still have some world class manufacturing businesses out there often engaged in high-knowledge and high-value production - competing on quality and craftsmanship rather than mass volume. The decision this week by the UK government to build two new huge aircraft carriers is an important shot in the arm for a number of UK manufacturing firms and this BBC report says that seven UK-based firms have won contracts totalling £91.5m to build parts for the new carriers.
Corus, based in Scunthorpe, will get £65m to provide steel whilst five other English firms, in Dorset, Greater Manchester, Surrey, Suffolk and Lancashire, will build products ranging from control towers to landing aids. Corus ofcourse is now owned by the Indian conglomerate Tata!
But a good example of how government capital spending can have potentially large multiplier effects if the initial contracts are given to domestic businesses.
The rest of the BBC article is here
Discretionary income takes a battering
Ernst and Young have published a survey of household discretionary income for the UK over recent years. Their definition of this measure of income is the income available for spending after tax contributions and essential monthly household bills and they have found that the average household is now 15 percent worse off than it was five years ago. It is interesting that we see so many different surveys and alternatives measures of living costs and guides to living standards these days as confidence in the official data such as the CPI have lost credibility and support.
read more...»Purchasing data hints that a recession is near
A double batch of new data on confidence among purchasing managers in manufacturing and services suggests that economic conditions in the UK are deteriorating quickly increasing the risks of a recession in the next twelve months. The Purchasing Managers survey’s headline index of overall conditions in the economy’s most crucial industries slumped to just 47.1 for last month. On a scale where any reading under 50 indicates contraction, this was the second month in a row that the numbers came in well below 50 and the downward slide is clearly apparent in our chart. Indeed this was the weakest reading on sentiment among buyers of raw mateials and components since the Autumn of 2001 and the immediate aftermath of the 9-11 attacks. Purchasing Managers data is often regarded as a lead indicator of turning points in the economic cycle.
Businesses hold the key to the next stage of the cycle
These are turbluent times for the economy - but the macroeconomic numbers of output, investment, jobs and pay are simply the aggegate of many thousands of decisions taken by individual businesses across the length nd breadth of the economy. How the UK economy emerges in the current downturn will depend crucially on the strategies adopted by the busines sector. It is a huge challenge - to make money and protect margins in a time when cost pressures are enormous, when demand might be slipping away and productivity growth is slowing down as capacity utilisation drops.
read more...»Confidence slumps - a tipping point?
Consumer confidence in the UK has slumped to its lowest level in 18 years. The latest consumer confidence barometer from GfK/NOP shows overall confidence in prospects for the economy dropped five points to -34 in June, only one point above the record low of -35 reported in March 1990. Plenty of reports on this today - here is the link to the Guardian’s coverage and also to the Times.
We should remember the usual caveats about this being a survey subject to sample error and that people’s expectations of where the economy is heading does not always correlate with their own experiences. The hard numbers on jobs, real take-home pay, housing repossessions and mortgage costs will have a heavier bearing on spending decisions in the near term. But these confidence numbers are truly dire and seem to suggest to me that 2009 will be a very difficult year for the UK economy.
Collapse in savings points to a very rough ride
Karen Ward from HSBC flagged this quite startling new figure for the UK savings ratio in her excellent talk on the UK economy at the London Conference on Friday. According to the Guardian, “Consumers are running down their savings to maintain spending, with the household saving ratio more than halving from 3% to 1.1%, the lowest since 1959.”
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