Tuesday, September 02, 2008

4 Right Wing myths about the economy, debunked by a wealth creator

I got sent this earlier by a friend who works in the City and who is not very impressed by some of the right-wing myths in circulation about the UK economy at the moment:

Claim 1

Our economy has stagnated (0% growth in Q2) whilst the US, the so-called epicentre of the crisis, grew 3.3% in Q2

This is incorrect. The numbers 0% and 3.3% refer to quarter on quarter growth (i.e. the US economy grew 3.3% over quarter two compared to quarter one). The more useful, less volatile and more standard measure is growth over a year before. Using the standard measure we get the following for the G7 (the most comparable economies to our own).

Country Q2 08 Q1 Q4 07 Q3 Q2 Q1
US 2.2 2.5 2.3 2.8 1.8 1.3
Canada 0.7 1.6 2.8 3.1 2.8 2.2
Germany 1.7 2.6 1.7 2.4 2.5 3.7
France 1.1 2.0 2.2 2.4 1.7 2.1
UK 1.4 2.3 2.8 3.1 3.3 3.1
Italy 0.0 0.3 0.2 1.6 1.7 2.1
Japan -2.4 0.3 0.2 1.6 1.7 4.0
UK Rank 3/7 3/7 1/7 1/7 1/7 3/7

So the UK economy is not only doing comparably fine and has been for the past 18 months.

On the quarter on quarter issue – the main reason the US grew so fast was because of the emergency fiscal stimulus (tax rebate) which cost US$150bn and probably cannot be repeated - an expense one quarter shot in the arm.

Whilst still on the issue of quarter on quarter growth – on that basis both Italy and France shrunk 0.3% in Q2 whilst Germany recorded -0.5%.

And let’s remember a recession is two quarters of negative growth in a row. We haven’t had one yet!

Claim 2

Northern Rock was a disaster. Why are we the only country in the world with bank failures?

Yes NR was a disaster, but the fault lies with the board for pursuing a stupidly risky growth model and the market participants that funded this growth.

In Germany IKB bank failed in June 2007. In Denmark (which incidentally is IN recession) Roskilde bank failed last weekend.

In the US, aside from the Bear Stearns bailout (which involved a $29bn loan), ELEVEN banks have failed THIS YEAR. The largest, excluding Bear, was IndyMac – which had a $32bn balance sheet- is the second largest bank failure in US history.

The Federal Deposit Insurance Corporation (FDIC, the body that steps in when banks fail) now has 117 (!) banks in the US on its ‘problem’ list at risk of failing. Now that’s a banking crisis.

Claim 3

The collapse in Sterling shows that Brown is lying

Let’s take this one in three parts. First off – yes sterling has fallen sharply in the last year – 17% against the Euro and 11.6% against the dollar.

However sterling has been historically strong – mainly as UK interest rates have been consistently higher than US and Eurozone interest rates for the past decade – this has helped to keep inflation lower but arguably badly hurt the manufacturing sector. The unwind over the past year is more a reversion to mean than a sign of a loss of faith in the economy. Against the dollar Sterling is still 14% stronger than in 1997. Obviously I can’t get comparable figures for the Euro (only introduced in 1999).

Point two, is this a bad thing? In a market economy the exchange rate acts as a natural stabiliser. We have imported too much abd not exported enough for the past decade. Weakening sterling will boost exports and lower imports – helping correct the imbalance. Notice that in the US over the past year, dollar weakness has helped cut imports and boost exports – narrowing the trade deficit.

Point three, are exchange rates a reflection of the strength of an economy? Not really. A good example is the yen – all over the shop in the 1990’s despite Japan’s ‘lost decade’.

Claim 4

We have a massive inflation problem and it will get worse, bring on the 1970’s.

Let’s get some perspective. CPI inflation is 4.4%, it’s 5.6% in the US and even using the older RPI measure ours is still 5%.

RPI hit 26.5% in 1975. It was at 10.9% in 1990. The average of the EIGHTIES was 7.5%. We do not have high inflation. We have marginally higher inflation than we have had for 15 years – 15 years in which the integration of China into the world economy acted as a deflationary force on the world economy and dragged inflation down.

We hear a lot about the rise in commodity prices. We here less about the recent and spectacular falls. From their highs (mainly May-June), have have commodites faired?

Oil -28%

Wheat -49%

Corn -25%

Copper -18%

Natural Gas -30%

Of course as the rises took a few months to feed through to consumer rprices, so will the falls. But the inflation outlook is not exactly scary...

I also notice neither the Mail nor the Express have put ‘Oil down 30% - Petrol price to collapse’ on their covers.

Let’s also note that inflation is the YEAR ON YEAR change in prices. Oil is still up 70% since this time last year – but for energy price inflation to be constant (let alone accelerating) then on 1st Sept 2009 oil needs to be at $178 a barrel. Somehow I don’t see that.

For what it’s worth I think we seen an increase in relative prices of commodities against consumer goods- this will lead to a short run spike in inflation (which are coming to the end of) and then things get back to normal.

Rising commodity prices are a catalyst for long periods of high inflation but not sufficient to cause them unless commodities keep rising at the same pace (and currently they are collapsing). Without a wage spiral, which there is very little evidence off, we won’t have a sustained inflationary period.

So everything is fine?

No. House prices will fall further. The economy will slow further as bank lending slows. Unemployment will tick up (although Eastern Europeans returning home might actually mean unemployment doesn’t rise as much as in previous slow downs).

But let’s not pretend that this is the end of the world or that we are doing worse than everyone else.


At 9:55 pm , Blogger Bloggers4Labour said...

Sadly the Tories (et al.) understand that the MSM will let them get away with just about anything at the moment (the "doing Britain down" argument is only wheeled-out when it suits them), and that if that's the way the MSM thinks the political wind is blowing, genuine economic analysis (like this) will go out the window in order that the Government gets the requisite amount of stick.

At 4:37 pm , Anonymous tim f said...

Wealth creator? That'll be by someone who does something of actual productive value, as opposed to someone who works in the city, then? :p

At 4:38 pm , Blogger Giles said...

Very good post, Don. It ought to be an article in a major newspaper, but of course they never see the point in making the "don't panic" point.

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