Meanwhile, in the UK, the various house price surveys suggest the market, once seemingly in free-fall, has turned the corner. The Nationwide index, for example, has risen for two successive months.
Elsewhere in the world, the decoupling debate, once confined to the rubbish pile of economic arguments, has quite rightly reopened. China delivered a stonking 7.9 per cent increase in GDP in the second quarter of 2009, in excess of expectations, which themselves had been steadily revised up over the last few weeks.
If sustained, these better-than-expected numbers may mark the beginning of the end of a global downswing which, earlier in the year, had threatened to become a Great Depression Mark II.
Nevertheless, there is still a lot of heavy lifting to be done. The level of housing activity remains very depressed and, for first-time buyers in the UK, it is a lot more difficult today to get hold of mortgages worth 100 per cent or more of the purchase price. Long term, that is certainly a good thing, but it is still acting to dampen activity in the housing market. Manufacturing activity around the world is hardly robust, a conclusion reflected in disappointing survey results published in Germany and the US last week. And, despite all the discussion about so-called “exit strategies”, we still cannot be sure what will happen when so-called quantitative easing finally comes to an end and central banks eventually choose to raise interest rates.
These uncertainties reflect the peculiarities of this economic crisis. The root cause of the crisis, at least as far as the conventional wisdom is concerned, was the appearance of excessive vulnerabilities within the financial system associated with inappropriate lending to sub-prime customers in the US housing market. The securitisation of those loans, and the eventual loss of trust in those securities, led to a massive collapse in financial confidence, the likes of which had not been seen since the 1930s. With some financial institutions now making money again, and with taxpayers’ money in some cases being repaid, is seems to follow that the worst of the crisis is now behind us.
All this may be true, but it’s certainly not the whole story. If some institutions lent “too much”, it must follow that others borrowed “too much”. One of the big lessons from Japan’s so-called “lost decade” was the importance of excessive debt. Even after banks found themselves in a position to lend again, lending remained stagnant because of an absence of willing borrowers. Almost all of the discussion we hear today revolves around the need to “kick-start” lending. I’m not so sure it will be that easy.
To a degree, the dangers of a borrowing shortfall have been masked by fiscal stimulus. Where the private sector has been unwilling to borrow, the public sector has stepped in. If a strong recovery is just around the corner, this may be no bad thing. If, however, private-sector spending remains constrained as a result of excessive debts, governments face a long, hard task of getting their fiscal houses in order.
Politicians have, so far, been happy to dance around the edges of this debate. American proposals focus on the reform of healthcare provision, while British politicians have simply discussed the relative merits of tax increases versus spending cuts. The really tough decisions still have to be made. In the UK, for example, how far will tax rates have to rise? Will VAT have to go up further? What happens to spending on education, health and helicopters in Afghanistan? Austerity will not be very popular, yet it will almost certainly be a longer-term cost of the credit crisis.
And while the recent run of economic data gives the impression of a “glass half full”, it’s quite possible that the glass has a hole in the bottom, allowing much of the apparent improvement in demand to trickle away without offering any real sustenance to the economy. The level of activity in many parts of the world remains very depressed, so much so that there is still plenty of downward pressure on prices and wages.
For those who like the idea of price and wage flexibility, this is a good thing. It’s better, so the argument goes, for everyone to receive a small pay cut than for 10 per cent of workers to lose their jobs. Generally, this is right, but the argument is undermined when interest rates have dropped to zero. At that point, further declines in prices and wages raise the real burden of existing debts. People stop spending, demand declines and the labour market softens still further.
All this suggests that while the worst of the crisis may be behind us, we have no right to expect a return to the conditions which prevailed before the crisis began, at least in the US and the UK.
For other parts of the world, however, the picture is a bit more hopeful. I’ve already mentioned China’s strong economic performance in the second quarter of 2009. My colleagues at HSBC in Hong Kong now think growth for the year as a whole could top eight per cent, with a further gain of 9.5 per cent in 2010. While, in the past, China’s rapid expansion has been attributed to a parasitic relationship with a rapidly expanding US economy, China’s recent return to form relies not on the US but, instead, on domestic pump-priming measures. Investment in newly started infrastructure projects, including an expanded rail network, rose 109 per cent in the first five months of the year, an enormous shift which will have knock-on effects on the demand for steel, cement, industrial machinery and so on. Already, the rate of profit decline is easing off and there are tentative signs of an improvement in consumer spending.
Combine China’s domestic strength with relatively loose global monetary conditions outside those countries afflicted by the credit crunch and you have a recipe for rapid domestic demand growth in parts of the emerging world. This, I think, means that decoupling is back. Domestic demand growth will probably remain weak in the developed world. Indeed, the US and the UK will increasingly encounter the demographic and debt constraints on economic growth which have so badly affected Japan over the last twenty years. The action will be elsewhere.
That doesn’t mean the world economy is out of the woods. Nevertheless, there are some signs of optimism here and there. Sadly, for the developed world, the most meaningful signs are coming from Asia and from other parts of the emerging world. That, though, is as it should be. The emerging world deserves to catch up. And the developed world, from both a lender’s and a borrower’s perspective, needs to grow up.
Stephen King is managing director of economics at HSBC
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