The Mystery Of Britain's Missing Recession

Fred Harrison - Mon 27 Jun, 2005

"...Just how did Gordon Brown abolish the boom/bust cycle? By letting industry fall into recession...by forcing families into debt...and by inflating a house price bubble that will cause the Depression of 2010..."

How did Britain avoid the 2001 recession that ensnared other countries? Recessions followed after each of the post-war periods when real house prices rose above the level of real household disposable income - in 1972, 1979 and 1987.

Britain's manufacturers did suffer a recession. Total output of the economy rose by over 5% from the end of 2000 to the end of 2003, but manufacturers had a different story to tell. They suffered a fall in output of over 5% in that period. The 6.7% rate of return on their capital (2001) was the lowest since the trough of the recession nine years earlier, in 1992.

So how did Gordon Brown guide Britain through the global turbulence of these years to avoid the embarrassment of a formal recession for the whole economy? His achievement provided him with a political narrative which he put to good use. One week before his 2004 budget he told the New Labour Party faithful at their spring conference:

"When I present my budget next week the first, the central and most important theme...will [be] for hard working families, to lock in economic stability...not just for a year or two, not just for an economic cycle. Our aim should be to lock in stability for a generation...we will take no risks with inflation."

Inflation, that is, excluding a large slice of the costs that people incur when they buy their homes.

According to the official definition of inflation, the one on which the Bank of England had to focus, Britain had enjoyed stable prices. But so, indeed, had the rest of the world. Japan's prices declined for a decade. Germany also appeared close to deflation. In other countries, inflation was moderate as retailers slashed prices to attract customers and producers competed for shares in the increasingly cut-throat global markets.

How, then, do we account for Britain's missing recession? Had Gordon Brown, the editor of unremittingly socialist tracts during his early political career, changed the rules of the capitalist economy?

The clues are to be found in the financial sector. Gordon Brown sponsored a classic Keynesian pump-priming operation. This time, however, there was one peculiar difference. Instead of accepting responsibility for managing the economy, he shifted the burden on to ordinary families.

According to the wisdom passed down through the decades since Keynes wrote his General Theory in 1936, governments could counterattack the prospect of a recession by employing offsetting measures. Unemployment was supposed to be due to a shortfall in the money people spent in the markets. So if government increased public spending, this would compensate for declines in private consumption and investment.

Brown stood this doctrine on its head. Instead of accepting the political obligation to maintain full employment, he silently shifted responsibility onto Britain's households. Instead of increasing taxes and/or public debt, to finance investment in infrastructure - to create jobs and sustain growth - he presided over the growth of a record level of personal indebtedness. By July 2004 that debt reached a staggering £1 trillion. To underpin this indebtedness, a blind eye had to be turned to inflation in the housing market.

If the business cycle had played out in the way that we would have predicted on the basis of historical trends, the price of houses would have deflated in 2001-2. This would have been the outcome of a mid-cycle recession. Instead, under Gordon Brown's stewardship, the residential sector was allowed to bubble. This set new benchmarks for prices: the next housing bubble would have to inflate to stupendous levels before finally collapsing and driving the economy into the Depression of 2010.

But in the meantime, Britain's consumers were on a spending spree. They borrowed like there was no tomorrow to finance the purchase of luxury goods, holidays in exotic locations, new cars, and improvements to their homes. Following the election of New Labour in 1997, consumption grew faster than output, with retailers sucking in imported goods to make up the difference. Between 1999 and 2001, consumption grew exactly twice as fast as Gross Domestic Product (GDP). Unsecured consumer debt rose at an annual average rate of nearly 11% over the five years to 2004. While Gordon Brown preened himself with declarations about his virtuous 'prudence' in handling the nation's public finances, he sanctioned private bingeing that undermined the culture of thrift. Britain's consumers would Spend, Spend, Spend the economy out of the recession before anyone noticed! They spent more on their credit cards than the rest of Europe put together. By 2003 those credit cards were loaded with a debt of £120bn. Shoppers in the other 14 nations of the European Union (EU) spent just £45bn between them.

The financial and psychological key to the spending spree was an out-of-control housing market. With every percentage increase in the capital gain on their homes, owners felt wealthier if not wiser. They withdrew equity at record rates so that they could buy the luxury goods that created the trade imbalance between Britain and the rest of the world. They also borrowed more to 'trade up' to more valuable properties - the home-owner's way of speculating in the capital gains of the future.

The hothouse finances of the nation were devastating for industry. They drove up the value of sterling relative to other currencies. Britain imported cheap goods from the Far East while her manufacturers suffered a collapse in orders. As Gordon Brown directed people's attention to the 2.5% target inflation rate, house prices were soaring ten times faster.

The Financial Services Authority (FSA) rang the alarm bells in January 2003. It described as 'unsustainable' the escalation in mortgage debt. And what was the Treasury doing about the borrowing binge? Gordon Brown failed to take effective action against the inflationary pressures coming from the one asset that mattered in his campaign to deliver stability. The official outcome was the appearance of inflation under control. This was a statistical illusion that was exploited for political gain by the chancellor.

In short, the UK economy escaped a formal recession in 2001 because Gordon Brown had imprudently allowed the population to neglect the need to save and invest. The nation's savings ratio sagged. It was over 10% of income when New Labour was elected in 1997, and it dropped to 4% in 2000; recovering a little, but dropping to under 5% in 2004.

Savings are crucial for at least two reasons. Money needs to be set aside in the form of pensions, if people do not wish to live on the breadline in their years of retirement. Secondly, the formation of capital equipment with which to compete in the global economy was crucial if the UK was not to be left behind by its competitors. It was incumbent on Gordon Brown to ensure that savings were sufficient to meet the needs of the nation. Strangely, the chancellor was silent on the prudential need to save.

In March 2004, a coalition of six investment organisations launched a campaign to try and stir interest in the Treasury on the need to save if the nation was to meet the challenges of the 21st century. The financiers were pessimistic, for "Mr Brown has not used the word saving in a Budget or pre-Budget report since 2001". The Association of British Insurers noted that saving was not one of the government's top five issues, and its members were concerned that the government did not have a co-ordinated strategy for filling a huge hole in the nation's finances.

The low savings rate aroused anxieties in the financial sector, but it made sense for the Treasury. It was bound by the rules of prudential management invented by Gordon Brown and his economic adviser, Ed Balls, a Harvard-educated journalist. Their way to avoid a formal recession was for the nation to deplete its savings, the reciprocal of which was for people to sink into debt.

So responsibility for the economy was covertly shifted away from the Treasury. Families were left to prime the financial pumps and keep the credit flowing so that the economy would not suffer six consecutive months of negative economic growth - the formal definition of a recession. Brown's role in disturbing people's willingness to save was criticised by Sir Richard Sykes, an adviser to the government and Rector of Imperial College, London. But the criticism came too late to moderate the Treasury's priorities.

The price of Brown's financial negligence would be a terrible one. For the best part of three years, beginning in the summer of 2001, the increase in financial liabilities of Britain's households exceeded the increase in assets. People were dangerously exposed to the vagaries of a world economy that was contracting.

If unemployment in the UK suddenly turned upwards, tens of thousands of families would be bankrupted, many of them forced to yield their homes to pay their debts. That this has not yet happened is not due to prudential management; quite the reverse.

The economy has stayed afloat because households sank into debt.


Fred Harrison
for The Daily Reckoning