Saturday, June 21, 2008

Brown's year in office

Spare a thought for Gordon Brown. His world has been turned upside down. Only a year ago, he was congratulating himself for the longest period of economic growth in British history. ”In this, my eleventh Budget” he boomed, “my report to the country is one of rising employment and rising investment; continuing low inflation and low interest and mortgage rates”

How times change. If he said that today, he would be laughed out of the Commons. Inflation is back, unemployment is rising, mortgage rates are rocketing, whole sectors of the economy, like construction, are collapsing and Britain is heading - almost certainly - for recession. The economy has turned bad with unprecedented rapidity and the new paradigms have been thrown out the window.

It wasn’t just Brown, of course - most economists were taken by surprise. No one forecast the August 2007 credit crisis, a systemic dislocation in the financial system which, as we learned last week from Bradford and Bingley, is far from over. We haven’t had a full blown banking crisis in Britain for thirty years and financiers like George Soros believe we are on the brink of a world depression. We’ve had an oil shock on top of an inflation crisis on top of a financial breakdown. Anyone who believes that this is an cyclical blip is not paying attention.

Yet last only last year, there was a widespread belief that the world was entering a golden age of low inflation, economic expansion and rising prosperity. People expected set backs, but nothing on this scale. Before Black August, the tills in the high street were bulging as Britain shopped till it dropped. Voters thought their houses were making them rich as New Labour’s easy money policies seemed to promise unbroken prosperity for doing nothing at all. The City of London was the financial centre of the world, a global hub of the new age of structured finance and credit expansion. People talked of the “Goldilocks economy” - not to hot, not to cold, just right.

Well, now the porridge is on the floor and Goldilocks is about to have her house repossessed. Last week the Paris-based Organisation for Economic Co-operation and Development effectively accused Brown of fiscal irresponsibility. His “excessively loose fiscal policy” it said left no room to cut taxes and prevent a steep decline. The OECD report was the latest in a blizzard of bad news for Brown. Bradford and Bingley, on of Britain’s biggest mortgage banks, nearly went the way of Northern Rock and had to be saved by a desperate cash injection from an American private equity company.

Halifax confirmed that UK house prices fell at 2.4% in May the steepest fall on record and mortage approval are down by nearly half. British housing market is around a year behind the US one and is going in the same way: down. Our sub-prime crisis lies in buy-to-let and self-certification mortgages and will prove just as toxic and damaging to banking balance sheets. And don’t expect the Bank of England to ride to the rescue: last week it made clear that there will be no slashing of interest rates to stop to collapse. Indeed, following hints form the European Central Bank, the smart money is now on interest rates rising in future.

This is the doomsday scenario which Brown thought could never happen - interest rates going up while house prices go down. The reason the Bank can’t cut interest rates is because inflation is back with vengeance. Annual food price inflation is running at 7% and fuel 9%
The pound is down 12% on the year raising fears of a run on sterling - something we haven’t seen for four decades. But with Britain’s balance of payments in the red, asset prices falling and the government in debt on the eve of a slowdown there isn't a lot of reasons for foreigners to put money in the British economy right now.

Britain PLC is looking a bit like one of the dodgy mortgage banks: pumped up with easy credit and ready to implode. The British consumer is the most indebted in the world, with a staggering £1.4 trillion in loans. Unemployment is set to rise. The financial sector looks like a basket case with Aviva announcing 1800 job losses.

Now the political question, amid the wreckage, is could it have been avoided? The answer is yes and no. You can’t blame Brown for the global credit crunch which began in Wall St. or for the quadrupling of oil prices. Nor can he be held to blame for the general breakdown in financial responsibility in society. However, he does carry the responsibility for not anticipating some form of economic downturn and stabilising the national finances to withstand it.

Brown used public spending to great effect after the 2000 stock market crash, when investment in the NHS and schools prevented Britain falling into recession. But overconfidence in his own economic infallibility led him to throw caution to the winds in the mid noughties. He didn’t need to put anything by for a rainy day.

Now the rain is pouring through Number Ten and Brown’s reputation for economic competence is being washed away. With hindsight his biggest mistake was not to understand the folly of the house price boom. But he wasn’t alone. The Bank of England kept interest rates far too low for far too long and allowed the genie of inflation to get out of the bottle again. Putting it back again won’t be pleasant.

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