Economic Update: March 2009 Professor Joe Nellis March 2009 SM
We are going to look today at the health of sick patient. That patient is the global economy. Joining me in the studio today is Professor Joe Nellis. Now, Dr Nellis, what do you ascertain are the symptoms of this ill health? JN Well clearly the most critical issue at the moment is the fall in international trade. Trade is the lifeblood of the international economy and of course capital flows, money flows, they fuel, they pump that blood around the system. So what we are seeing is a significant drop in exports from some of the major economies, such as China in particular, and Germany which is the world’s biggest exporter, into those economies such as America and the UK which are slowing down rapidly. SM Now I gather that the World Bank is saying that this is the largest fall in trade in eighty years. JN Absolutely. We are in record territory at the moment. The fall is obvious. America is the world’s biggest economy – when America sneezes the world catches a cold, the usual cliché. And America is now affecting all of us in different ways. Those economies, as I said earlier, that are dependent on American demand are now really feeling the pinch and so this drop in trade is going to have significant implications for the global balance of power, of economic power. What it means simply is that the big trade surpluses, China and Germany, are going to decline but equally the big trade deficits of America in particular are also going to decline. And therefore the global imbalances will improve. SM So lets explore then – who are the biggest losers in all of this? You mentioned those dependent on the American economy. JN Well, again, we have mentioned China already, but there are many other economies that also export to America in terms of commodities etc. Look at oil prices, they have come down from a record high of almost $150 a barrel less than a year ago, to over $40 a barrel. So the oil producing countries have lost a huge amount of revenue which they would have expected to get a year ago and now they have had to adjust to that. So, for example, economies around the world such as Brazil which export not only oil of course, but commodities to America they are struggling and these economies need America to recover quickly of course. SM Are there any sectors that seem particularly affected – the ones that have caught the headlines in this country are retail and manufacturing? The car Professor Joe Nellis industry seems on its knees, when we are getting people like General Motors saying that they can’t carry on much longer it shows they are in real trouble. JN They are in real trouble. Let me deal first of all with what we have called the big losers. The most obvious one is, of course, the housing market. The estate agents, the banks that provide the mortgages, of course, the house builders are really in trouble because house building has not stopped, but it has almost come to a halt, which means that there is no cash coming into those organisations. On top of that, of course, we have the banks themselves. The root of the problem. And it is going to take a long time before we see that unravelling. But there are other sectors that are doing very badly which we shouldn’t forget. In particular the so‐called discretionary items; the cars that you mentioned. Again this is cash flow. Let me explain it in a bit more detail. The car manufacturers allowed their stock levels to build up as demand fell. Even if we have a recovery in the next twelve months, which I don’t think we will, those stock levels have to be reduced before production picks up again. It is going to be a long term structural adjustment for those sectors. And lastly, and not least, is the media sector. Advertising expenditure falls in times like this and so we are seeing companies like ITV see significant losses build up on their books as the economies slows down. Those are the losers. I am hoping that you are going to ask me about the winners, of course – some good news. SM Yes. Very locally, local free papers newspapers seem to have been very badly hit and we might see the complete disappearance of those from what people are saying? JN Possibly, because they rely on advertising – totally in fact. So they could well go out of business, some of them, but there will be life after death so let’s not be totally pessimistic. SM Well let’s look on the plus side then. What are the winners? JN There are several actually. Can I start with education? In a downturn the best place to be is actually in education and training. SM That sounds like good news to me for us. JN It is good news for business schools in terms of the degree programmes of course, not necessarily in the non degree programmes. But I would expect to see a significant increase in university applications this year as students realise there aren’t any jobs available or there are fewer jobs available, so Page 2
Professor Joe Nellis let’s go into education. That is one winner in the coming years. There are other winners of course. The companies that focus on energy saving. Loft insulation is booming at the moment and the government is supporting that – it’s a good environmental policy, as well. But those sectors in terms of saving us money are going to do well. There are many others: the public utilities, people still heat their homes. People still turn the lights on. In some ways they actually stay at home more and therefore the service that they use increases. And of course in the general retail sectors we are seeing a significant increase in sales in those companies which have let’s say the lower end of the market – the Aldis, the Lidls of this world. But anybody in the economy sector, the cost saving sector is doing quite well. SM And presumably one of the things that has come under quite a bit of criticism is the size of the government sector. Presumably that is going to continue because we need to pay out unemployment benefits and so on and provide extra services? JN Government spending is going to keep rising and that is going to put real pressure on government finances – how they pay for this. There is a real problem building up in the years to come of course as we have to pay back that government borrowing in some time in the future. It is estimated that even if they start paying back, clawing back from us, £20bn a year, it’s going to take to 2030 until we start to see the debt levels come down significantly. So government borrowing is a real problem for the future, but of course it’s essential today. SM Let’s look at unemployment figures. They have just been announced in the UK. The figures are rising quite quickly and they are predicted to go even higher aren’t they? JN Yes. We are currently now officially at over two million. I would like to qualify that – that is two million people claiming unemployment benefits. Let’s remember if we go back about ten years ago there were over half a million people on the so‐called ‘sick list’ who were not unemployed as such, but they were on sickness benefit. Today that sickness benefit total is now 2.7 million and rising. So when we say unemployment over two million, it’s probably a lot worse than that. But those are the official figures. How high will it go? Well I think all forecasters are predicting unemployment going above three million. The last time we were at those sorts of levels was in 1984. In 1984 we hit 3.27 million. We could well touch that again, but remember it may even be higher than that because of the way we measure unemployment today. And that is a real problem. Page 3
Professor Joe Nellis SM On a more positive note, one or two people and only one or two, are saying that there are may be just the first signs of the green shoots of recovery – can you see any? JN Not in the UK at the moment. There are some green shoots appearing slightly in America in the last week or so. There has been a pick up in house building in America surprisingly. But you know, I think we are all looking for the green shoots and hoping what we see are indeed signs of recovery. Perhaps the most positive bit of news in the last few days was Ben Bernanke the Fed Chairman, he has come out officially and said that he believes that America will come out of this recession later this year into early 2010. But that is America, remember America was first to go into this recession, and it is not surprising therefore given the scale of pump priming by the government and the extent to which they injected liquidity, it wouldn’t be surprising if they are the first to come out as well. But that doesn’t mean the UK will come out at the same time. So I think we are still twelve to eighteen months behind America in terms of the phase of recovery. SM Now one of the things that I find quite interesting is that different governments are taking different approaches. So the Americans seem to be taking a different view from the UK, the UK is taking a different view from the Germans for example. Would you like to comment on that? JN Yes. I would say that America and Britain are actually agreeing on a lot of measures that they are taking in terms of injecting liquidity – the so‐called quantitative easing – and we have just begun that. Of course in Continental Europe, in mainland Europe, particularly Germany, they are much more prudent and that is part of their culture. They haven’t had the same sharp decline that we have had. They don’t have the same exposure to the housing market; there is not the same level of personal debt. So they are being much more cautious and in fact resisting some of the recommendations of Gordon Brown to pump more money into the economy. But I think that the UK and America share a lot of similar views on this. SM Let’s talk a bit more about quantitative easing. It’s a term that is bandied around. I am not really sure that everybody understands what it is about and what effect it is going to have. JN Let me clarify that for you. It actually officially began last Friday – Friday 13th, a rather interesting date to start your quantitative easing. The Bank of England said to the market that it is willing to spend up to £2 billion buying government and corporate bonds that institutions and others hold. Amazingly it was offered five times that amount by the market. In other Page 4
Professor Joe Nellis words the market was keen to get some of this liquidity. So all that is happening is, and will continue to happen over the coming months, is a swap of liquid assets – money if you want to call it that – provided by the Bank of England to the market in exchange for their government bonds and gilts. Of course the market is not willing to sell these unless they are able to sell them at an attractive price, and indeed that is what has happened. The price of bonds went up last Friday, and the yield therefore in bonds, went down. And the yield is now about three per cent, which is lower than the yield on bonds in Germany which means our government, if it wishes to issue new bonds, can now raise money cheaper than the German government can raise money. But let’s be very clear, quantitative easing is simply a swap of liquidity for less liquid assets ie, bonds, and the hope is that those institutions that now have that liquidity will go out and spend that liquidity again – perhaps on stocks and shares or perhaps lending it to borrowers. So we are hoping that this will stimulate spending in the coming months. SM Finally Joe, we have learnt some new lessons, some new tricks if you like, quantitative easing for example. We have maybe re‐learnt some old tricks. What would you hope that we have learnt out of all this? JN I am not sure that we have yet learnt whether or not quantitative easing will work – so we wait and see. I think there is one huge lesson from all of this, and that is personal borrowing will have to be reduced significantly in the years to come and it won’t happen overnight. Banks and building societies that provide mortgages in excess of the value of the property, I think those days are gone for many years to come. So excessive borrowing, excessive exposure to debt levels – leverage – I think that is the biggest lesson and if we think of the Continent again and Germany and France and many other countries, they have been less effective because they have got a much stronger culture of saving up for a deposit to buy a property. I think that is the biggest shock to our system. And of course the consequence of that is if people now have to wait longer to buy their first house, because they need a deposit, that is going to mean that the housing market will take much longer to recover. The housing market depends on first time buyers. To me that is the biggest single impact that there will be on our culture: the importance of saving a deposit for a property and I think that will be several years before we really see the benefits of that. SM Joe, thank you. JN Thank you. Page 5