When I first started out on the bond markets, an older and wiser colleague took it upon himself to warn me of the pitfalls of dealing with unscrupulous brokers. “Watch out for salesmen selling recovery stories,” he advised. “Never forget the definition of a bond that was down 50 per cent and then recovered 50 per cent. It’s a bond that has lost 25 per cent.” I can’t help thinking of this homely piece of wisdom every time I read another story about the UK’s loudly hailed recent recovery.
It is true that the UK’s gross domestic product (GDP) grew by nearly 2 per cent in the four quarters to September 2013, compared to barely more than 1 per cent over the whole two years before that.
The trouble is that this still left the economy nearly 2 per cent smaller than it was at the end of 2007 – more than six years ago. As my former colleague pointed out: when there’s been a precipitous crash, you need to pay attention to levels of growth as well as growth rates if you want to avoid bamboozlement by sales pitches.
It’s not that the recent good news about the UK economy is all hot air. Not only has growth picked up, but unemployment is down. A little over two years ago, the unemployment rate hit 8.4 per cent. Since then, the economy has added a million jobs and unemployment has fallen to 7.4 per cent. Monetary policy, too, is finally enjoying some success. In December, inflation dropped back to the Bank of England’s target of 2 per cent for the first time since 2009. Two years ago, prices were rising by more than 5 per cent a year. Britain’s wage-earners can dream once more that rising real earnings, last seen before the 2008 financial crisis, might be back.
There has even been progress on the reform of finance. Last year, the Parliamentary Commission on Banking Standards subjected Britain’s policymakers and financiers to previously unknown levels of scrutiny, and the new Financial Policy Committee was established at the Bank of England in 2011 to oversee the stability of the UK’s financial system.
However, the moment one begins to take a longer view – and especially to pay attention to levels as well as rates of growth – the clouds loom.
To start with the labour market: the good news is that the number of unemployed people actively seeking work has shrunk by 250,000 since its peak in 2011. The bad news is that this still leaves 770,000 more people unemployed than at the end of 2007 and the total number of unemployed, at 2.4 million, barely changed from what it was in May 2010.
Much more worrying is the very long-term picture. In the 25 years after the Second World War, the unemployment rate in the UK averaged less than 2 per cent. Since 1980, it has averaged nearly 8 per cent, and even during the 15 years of uninterrupted growth between 1992 and 2007 it only ever spent a couple of years below 5 per cent.
The long-term question, in other words, is whether the UK economy is any longer capable of generating sufficient jobs to absorb all the people who want to work. For the past 30 years or more – regardless of government and regardless of the cycle – the answer seems to have been that it is not. Instead, we have simply got used to a society in which a sizeable proportion of the labour force doesn’t work, even if it wants to.
The recent success of monetary policy is also a bit of a mirage, or at least only part of the story. The combination of low interest rates and stable inflation is in principle a good thing (not that it helped forestall the crisis in 2008), but it can be beneficial only if the banking system transmits it to the broader economy.
On the monetary front, the innovative policy of quantitative easing has increased what is called the “monetary base” – cash and coins, plus the deposits at the Bank of England that the commercial banks hold in reserve against emergencies. But this base money is a tiny part of the money supply at large. What matters for spending and investment is “broad money” – the monetary base plus businesses’ and households’ current and savings account balances at the commercial banks – and this has in fact contracted marginally over the past three years. Meanwhile, bank lending to the private sector has not only stagnated, but continued to plummet, falling more than 14 per cent over the same period.
As for financial stability, regular readers of this column already know my view that the well-intentioned effort to fix the banks is creating new problems elsewhere. The regulatory generals have been fighting the last war as the collapse in bank lending has been replaced by a boom in the corporate bond markets. How this new and untested system for delivering credit to UK plc will weather a hike in interest rates when it eventually arrives, nobody knows. I am not convinced it will be pretty.
However, the biggest problem that the boosters are ignoring is with GDP itself. For more than 60 years after the Second World War the UK economy used to grow, in real terms, at roughly 3 per cent a year. Such deviations from this trend as the Lawson boom of the late 1980s, or the recession of the early 1990s that followed it, were always corrected quite quickly.
For reasons no one yet understands, this time is different. The only sure thing is that a return to the pre-crisis trend is a pipe dream. Had the economy continued to grow at 3 per cent a year since 2007, GDP today would be nearly 20 per cent larger than it is. Making up the lost ground by 2020 would require the economy to grow at more than 5.5 per cent a year from now until then. Even the most brazen salesman in the world wouldn’t suggest that’s about to happen.