GDP falls steeply by 1.5%

With today’s figures indicating that the Gross Domestic Product fell by 1.5% over the last three months coupled with the previous quarter’s drop of 0.6% meant that the UK is finally officially in recession after two quarters of negative growth.

Here is the breakdown

• Construction output – down by 1.1 per cent
• Total production output – down by 3.9 per cent
  • Manufacturing output – down 4.6 per cent compared with a 1.6 per cent decrease in the previous quarter. 
  • Mining and quarrying – down1.6 per cent 
  • Electricity, gas and water output – down 0.2 per cent
• Services output – down 1.0 per cent 
• Distribution, hotels and restaurants : down 2.4 per cent,
• Transport, storage and communication : down 2.0 per cent
• Business services and finance : down 0.5 per cent
• Government and other services output : down 0.5 per cent,
• Agriculture, forestry and fishing output : up 0.1 per cent 

It is difficult to see anything trending back up in the near term except perhaps government output as public spending is increased. Inevitably the private sector is going to suffer most contraction in trying to survive the credit crunch.

Economists do not expect recovery to start until 2010

Most economists expect the recession to last a further year at least, as it will take some time for the government’s measures to take effect.

Graeme Leach, chief economist at the Institute of Directors

We are well into the financial crisis but the economic crisis is only just beginning.

John Cridland, CBI Deputy Director-General

Looking ahead, we hope the impact of interest rate cuts, falling inflation, the fiscal stimulus and the Government’s recent measures to kick-start lending will have a stabilising effect later this year.

David Kern, chief economist at the British Chambers of Commerce

While the short-term outlook is dire, it is important not to drift into excessive despondency. The Government and MPC still have important weapons at their disposal, which they will undoubtedly deploy. The huge stimulus package that the new Obama administration plans to introduce could have beneficial global consequences.

 
So there is a view that the government is doing the right things to mitigate the length and depth of the recession.

Gordon Brown needs to apologise

The best that Gordon Brown can hope for, is to persuade us in 2010, that his good financial management meant we only had a recession whereas under a Conservative Government it would have been a depression. It is a hard sell and unlikely to work. Unless of course, he fesses up to having made some mistakes with public spending and apologises for that ridiculous ‘We will not return to the old boom and bust’ statement on 21st March 2007.

The other thing he could do is reach out to the Conservatives (Cameron and Clarke) and the Liberal Democrats (Clegg and Cable) to get cross party support for decisions that will impact the country for next three or four parliaments. Obama is doing likewise with the Republicans in the USA. Brown should follow his lead.

A truly historic day as America’s most talented politician, Barack Obama, assumed the presidency of the United States of America. High on his rhetoric, his idealism, his realism and his hope, I am only more optimistic about the future.

The democratic election of a non white president, son of Kenyan father and a Kansasian mother, is the realisation of the second glorious sentence in the Declaration of Independence:

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.”

As for his view of the credit crunch, he did not pull his punches, and does not underestimate the scale of the challenges ahead. He could be talking about any Western nation…

Obama’s Analysis of the Problem

“Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age. Homes have been lost; jobs shed; businesses shuttered.”

Obama’s Solution

“The state of the economy calls for action, bold and swift, and we will act — not only to create new jobs, but to lay a new foundation for growth. We will build the roads and bridges, the electric grids and digital lines that feed our commerce and bind us together. We will restore science to its rightful place, and wield technology’s wonders to raise health care’s quality and lower its cost. We will harness the sun and the winds and the soil to fuel our cars and run our factories. And we will transform our schools and colleges and universities to meet the demands of a new age. All this we can do. And all this we will do.”

Balance of Power shifts towards a Benevolent State?

The relationship between the state and the individual will change, the ‘invisible hand’ of the market won’t be cuffed, but will be gloved (i.e. greater transparency), and the USA will aim to live up to the high principles of liberty and equality to which it has mostly only paid lip service. Very interesting times ahead!

However, we are not all going to buy into big government, high taxation, more regulation, more intervention and less personal power (unless things get better). Yet it might be the right solution right now. We will find out soon enough.

Today the UK government launched their last attempt to unfreeze the credit markets with a three pronged bank loan scheme:

• Working Capital Scheme – cost £10bn – provides a 50% guarantee on £20 billion of short term loans to businesses with a turnover of less than £500m with banks having to register a portfolio of such loans through the BERR (Department for Business, Enterprise & Regulatory Reform). The BERR will charge a premium for the guarantee which will likely be passed on by the bank to the borrower
• Enterprise Finance Guarantee Scheme – cost £1.3 billion – provides a 75% funding on a scheme for new 10 year loans of between £1,000 and £1,000,000 to small to medium size companies with turnover less than £25 million. High street banks provide the other 25% of funding
• Capital for Enterprise Fund – cost £50 million – provides a 66.6% funding on a scheme where companies with up to £50 million turnover sell their debt for an equity stake of between £0.25 million and £2 million with the four main high street banks providing the 33.3% funding.

I guess the goal is to allow the banks to take another look at the loan requests that fell just outside their current strict lending criteria. With the guarantees in place the banks’ capital requirements are reduced and hence it can make more loans.

However, I can live with the first of these schemes but not the other two as I believe it is inadvisable for the government to put in more than a 50% guarantee or contribution. Any more than 50% really begins to prejudice the lending decision.

As typical with bureaucrats, we have three schemes with different entry criteria and qualifications and this will no doubt suffer from unintended consequences. [Please give me one rule that I can understand rather than three rules where I need a lawyer and an accountant to interpret them.]

Alternative Bank Loan Guarantee Scheme

I would propose a much simpler approach: one scheme rather than three.

• Its goal would be to address those viable businesses needing affordable loans that have only now fallen just outside of the banks’ tighter lending policies.
• a single scheme 
• open to companies up to £100 million revenues 
• loans up to £1 million 
• 30% government guarantee 
• total volume is £38 billion of loans. 
• total scheme cost is the same being around £11.4 billion. 

With my approach less bad loans would be made as the banks would look harder at the lending decision and therefore we can expect less defaults, and less cost to the taxpayer.

Rationalisation for Nationalisation

If the bank loan scheme fails, then what is the next step? Nationalisation?

(Futher) nationalisation of the banks is an interesting prospect. The analysis goes

In summary, the problem was ‘too much easy credit’, and the solution is ‘more easy credit’.

In this scenario, we would definitely need a very light touch on the supply of credit as soon as we look like coming out of recession. Otherwise we will be looking at very serious inflation. It is bit like driving up a steep hill in an old car where you floor the gas pedal but need get the power off quickly just before you hit the summit. Nationalised industries are not known for being ‘quick on their feet’ and ‘having a light touch’ faced with a rapidly changing marketplace. We would half down the hill, in the red, with no control over the steering by the time a nationalised bank realised an adjustment was needed. In other words, a recipe for disaster.

Nationalisation of the Banking System

If you are going to nationalise banking this would be my recipe:

And if I was feeling a bit like ‘Big Brother’:

Maybe it is just as well I am not in power.

The Bank of England dropped interest rates by 0.5% to 1.5%, the lowest level ever.

This is unlikely to have much effect on the level of bank lending as banks will take the opportunity to wider the spread between the rate thay borrow at and the rate they lend at.

The 363 rule of banking, just got better: borrow at 3% , lend at 6%, golf course at 3 o’clock.

The pumping of government money into the banks has helped over the last 3 months as the spread between LIBOR and Bank of England rates has narrowed to 0.85% prior to yesterday moved.

I would expect LIBOR to creep down to about 2.5% and hence allow the bankers to be on the golf course by 14:30, which is very amiable given the dark winter evenings.

In the UK, David Cameron set of an alternative to the consensus view of increased public investment and spending, in response to deepening downturn in the economy.

Is he a) enlightened? b) economically inept? c) partisan?

Let’s look at his proposals:
• Remove tax on savings up to the basic rate of 20%.
• Increase tax free allowances on savings for the retired.

Cameron the Enlightened

The problem that Cameron is trying to solve is that of the low returns to savers. It is generally recognized that giving people their own money back is a more effective way of growing the economy than large scale public investment so his proposal is encouraging in this respect.

Also Cameron’s proposal is cheap at this time because interests rate are so low. If you are getting a 2% return on your money, then the tax saving under Cameron’s plan is 0.4%. With the average saver having £10,000, that amounts to £40 a year or about £0.80 per week for the saver.

Cameron the Inept

This compares to the 2% reduction in Valued Added Tax ( a natonal sales tax). If the average person spends £75 a week on vatable items that this reduction will result in a £1.50 per week saving. So Brown’s proposal is on average about twice as effective as Cameron’s.

However, look at who is affected by the changes: the VAT savings proportionally help lower income families more while savings tax changes would benefit middle income more.

Cameron heavily criticised the VAT reductions but his proposals are even more ineffective.

Cameron the Partisan

The increase in tax allowances is really a give away to his supporters. It is targeted at the retired, middle income who are indeed suffering a fall in income as the returns.

The tax system already allows £7000 in tax free ISAs and through Post Office accounts, so the most substantial beneficiaries of his the proposed tax allowance increase would have savings of over £10,000.

However, now consider the scenario where interest rates resume normal levels of 6% as they must do in the next couple of years. The cost of the tax giveaway will be six fold what it is now and with the benefits going into the pockets of his supporters.

Conclusion

Savers will reap the just rewards of their savings but only once when we come out of recession.

Cameron does need to come up with alternative policies to the Labour Government but he needs to demonstrate he has some understanding of the economy and what is good for the country as a whole.

For example, he should agree with the current level of public investment but come up with a different set of priorities on that spending and propose putting in place a set of measures and controls to ensure the public is getting the best possible value for money for these initiatives. This would be a credible approach.