Vericool Finance

“Don’t be fooled by one month’s data” is one of the first lessons taught on any good economics course. Yet the accumulation of upbeat stats can no longer be ignored.  Rather than the odd green shoot, the economic landscape now resembles a fragile carpet of green, and economists are busy revising their forecasts higher.

The most weighty of the green-shootists is the National Institute of Economic and Social research.  If the NIESR is right, and they have been in the past, there’s a good chance that official GDP figures could show a flattening in the second quarter and a return to growth in the third.  Good grief!  The Chancellors’ much-derided Budget forecast could turn out to have been right all along.

Perhaps there is an economist’s recovery but, with large numbers of job losses still to come, the pain for many ordinary Britons is just beginning.  Meanwhile there’s a danger that we lose something crucial amid all the green spouting.  Momentum for reforming the financial sector and for rebalancing the UK economy was strong in the depths of crisis.  Now it is palpably slipping away… on the slenderest of pretexts.

Forget green shoots, GMB union leader Paul Kenny said, what we are actually seeing is “greed shoots”.  The “recovery” seems to consist largely of bankers getting “the financial gravy train back on the tracks” – witness the recent huge payouts at Barclays.  Yet it is clear that the banking system is not yet out of the woods.  The ECB warns of a further bank writedowns totalling $283bn this year:  a bleak outlook.

There is now a big risk that central banks and governments will move too swiftly out of recession-mode strategy and begin reversing their supportive monetary and fiscal policies.  There were hints of such exit strategies at the last G8 meeting.  Yet there is still meltdown potential, especially in Europe.  Latvia, for example, is a ticking time bomb.

Some economists think that the world has dodged a bullet.  The risk of an all-out Great Depression… has receded, but historical analysis by economists Barry Eichengreen and Kevin O’Rouke gives pause for thought.  The bad news is that this recession fully matches the early part of the Great Depression.  The good news is that the worst can still be averted.  But we shouldn’t delude ourselves.  The path to full recovery is likely to be long, hard and uncertain.

The recession ended in May.  Whether or not you believe that to be true, the one thing Gordon Brown hasn’t had to worry about recently is the economy, which is staging something of a fightback.

It looks like output will start to grow again by the end of the year.  But the recovery will be sluggish, and could be short-lived – and swingeing job cuts and business insolvencies could make it feel far worse next year.  So what are we to make of the bizarre appointment of Sir Alan Sugar to the House of Lords as enterprise tsar? A serious man for serious times, no doubt.

Sugar seems to have a lifelong gift for boarding sinking ships, leaving computers for property and property for politics.  Yet, as he has shown on The Apprentice, at least he is comfy on camera – which is more than the PM can say.  How Gordon Brown must envy him.  He doesn’t have charm.  There’s no sign of any emotional intelligence.  His sense of humour is oddly stunted and he’s stubborn, arrogant and mouthy. And yet the public not only love him, but back him in their millions with their remote control.  But will he get results?

Sugar’s stated aim is “to help out businesses and act as a kind of giant Dragon’s Den… although not with my money”; he plans to act as an intermediary between banks and companies.  But that may be as empty a promise to the average small business as every other emergency enterprise package:  you only get the cash if you can show you don’t need it.

Sugar’s recent track record in business hasn’t exactly been brilliant, and he’s not always the most prescient forecaster:  “Next Christmas, the iPod will be dead, finished, gone, kaput,” he predicted in 2005.  But there’s a lot more to him than boardroom bluster.  The Amstrad PC genuinely revolutionised consumer electronics in Britain, and that alone makes him a business visionary.  But that was a long time ago and you’d think the less-than-happy experience of Lord (Digby) Jones in Whitehall would have dulled Brown’s enthusiasm for bringing bumptious businessmen into the big tent.

You can’t help thinking the PM has missed a trick.  Who better to knock the banks into line than Sugar’s sidekick, Margaret Mountford?  The strategic application of that sceptical scowl and cocked eyebrows would soon stop them coming up with another fiasco like subprimes. Never mind Lord Sugar, bring on lady Salt.

On the face of it, it is clear why Standard & Poor’s has cut Britain’s debt outlook from “stable” to “negative” for the first time in decades and threatened to strip us of its cherished AAA rating for the first time ever.  After all, new stats show that government borrowing surged fivefold in the year to April, while tax receipts slumped 10%.

S&P warned that the UK’s ratio of debt to GDP could be about to double to 100% and stay there – and they might be right.  On the other hand, these are the same people who brought you triple-A rated collateralised debt obligations, rock-solid Icelandic banks – and failed to predict any of the financial crises of the past 20 years.  Ratings agencies always accentuate the book and exaggerate the bust, and this latest offering is typical of their output:  a risible piece of guesswork.

That said, it’s not too hard to spot the gigantic hole in the UK’s public finances,  and it doesn’t help that the Bank of England’s quantitative easing strategy has meant that it’s busy buying back the Government’s own debt from lenders – underpinning and distorting the price of gilts.  Ernest Saunders went to prison for doing something similar.

S&P aren’t saying anything that hasn’t been well documented by any number of other worthy bodies – including the IMF.  The S&P downgrade matters, because if we lose our AAA rating, our problems will be much worse.  Foreign investors buy two-fifths of our government debt, and many of them are only allowed to hold paper with a pristine rating.  That’s scary.

Given the current political disarray, it was no surprise that the Treasury couldn’t come up with a convincing response to S&P.  They need to – and fast.  When it comes to getting people to lend money, Britain has historically relied on two factors: its strong and stable governance, combined with a history of paying our debts back.  There is no fundamental reason why that can’t continue.  Even the chasmal fiscal deficit of 12.4% projected for 2009-10 is affordable as a one-off, but only if investors are told how the Government is going to pay them back eventually.

Instead, Britain is suffering from a credibility gap.  With the expenses scandal and uncertainty over the state of the election causing political paralysis, and neither party remotely clear about their future tax and spending plans, the UK looks financially exposed and politically weak, and that’s perfect ground for ratings agencies to wreak their usual havoc.

They say you know the tide has turned when the last great pessimist throws in the towel.  So there was some significance in George Soros’s recent pronouncement that apocalypse has been avoided. “The economic freefall has been stopped, the collapse of the financial system averted,” said the billionaire investor whose graphic warnings of imminent doom shocked the world last year.

And all around, it seems, there is optimism that the worst of the slump may be behind us.  Commodity prices are rising, indicating that global manufacturing demand may be picking up; investors seem willing to stump up cash for banks and companies; even the OECD now indicates that a sharp bounce in April activity suggests that the best-case scenario – a V-shaped recession – is no longer out of the questions.

But, there’s a big difference between an economy getting worse more slowly and one that is on the path to recovery. Even if modest signs of improvement develop into rising output by the autumn, there is still a strong risk of relapse into a double-dip recession. The bank of England recognises as much:  its move to step up quantitative easing with an extra £50bn shows it believes the banking system remains fragile. And unemployment, up by almost 250,000 in Q1 (the biggest quarterly rise since 1981), still looks worrying.

We can’t assume the international outlook is altogether rosy either.  It would take a sustained rise in Chinese exports to suggest that demand in the rest of the worlds has turned, yet they fell by 3.5% between March and April.  And US property prices are still falling, while losses at Wall Street banks continue to mount. As Gordon Brown never tires of telling us, this crisis began across the pond.  And that’s where it will end.

Green shoots have been proliferating in the hothouse of the financial markets, but step outside and the climate is very differen.  Bank governor Mervyn King’s withering summary of conditions suggests an economy that, rather than shooting, looks shot.  Recovery won’t begin until 2010, King said, and even then there are pretty solid reasons for questioning if that will be sustained.

The coming years will certainly be rough, yet the nation today is markedly different from the shabby, defeated country we were in the 1970s.  Britain, in fact, seems determinedly cheerful.  Why?  Perhaps because, although things are bad, no other country seems to be doing markedly better; or perhaps because – having dug ourselves out of a hole once before – we feel we can do it again.

It is considered a golden rule in politics that Budgets that look good on the day, start to look poor by the weekend and vice versa.  Last week’s Budget broke that rule.  Even the dreadful borrowing figures announced by the Chancellor of the Exchequer last week – pushing the national debt well beyond £1trn – were not dreadful enough to describe the reality, as became clear within days, when a set of shocking GDP figures recorded a contraction far worse than expected. Over half a trillion pounds of borrowing is scheduled over the next few years.

It could easily be more. On the Government’s own forecasts, the public finances will come nowhere near balance until 2018.  Some experts reckon we’re looking well into the 2030s or the 2050s.  “In the long run”, Keynes famously said, “we are all dead”.  But this is getting ridiculous.

The Chancellor has admitted the Government needs to borrow £220bn in the gilts market this year, just to keep finances afloat.  After that, he claims, things will start to get easier.  Really?  Darling’s expectation that the economy will shrink by “only”3.5% this year already looks out of date.  But this wildly hopeful assumption that this decline will somehow reverse into a growth rate of 3.5% in two years’ time seems preposterous.

Using the IMF’s more neutral economic forecasts, Monument Securities reckons Britain will have to tap gilt buyers for some £230-235bn this year and about the same in 2010/11.  At the moment, the Government is having little trouble finding lenders:  the increased supply of gilts is being soaked up by the Bank of England’s £75bn quantitative easing programme and by foreign buyers.  But if investors begin to doubt the Government’s ability to close the deficit, the market’s willingness to refinance sovereign debt could come to a sudden halt.  Epithets of “banana republic” and “sick man of Europe” may yet return to haunt the British.

Britain does have one advantage.  It entered the recession with relatively low levels of public indebtedness compared to other countries.  This means that, even with a dramatic surge in liabilities, it will end up with only a middling level of debt compared with G7 countries overall.  Yet we shouldn’t take refuge in that.  On some measures, Britain’s public finances are now the worst of any rich country: next year, we will probably have a bigger deficit, as a percentage of GDP, than the like of Italy.

Retaining market confidence calls for plausibility and willingness to forego overly optimistic forecasts.  The only way out is to confront the problem head on.  This dishonest Budget has done Britain no favours at all.

You’ve got to hand it to Alistair Darling.  Only this most emollient of politicians could manage to make this Budget seem boring.  Yet the content of the speech was, in many ways, explosive.  He told the country that British prosperity was, in important respects, as fraudulent as collateralised debt obligation; that the boasts of ‘no more Tory boom and bust’ are a joke; that the economic forecasts he gave only last November were nonsense, and the public finances are deteriorating at a rate never seen before in peacetime.  And all with a deadpan face.

Darling announced a rash of measure to steer Britain towards recovery, but the Chancellor’s efforts to offer a little to everyone failed to find approval in most quarters.  Indeed, he faced a chorus of disappointment.

Apart from the sheer mess of the economy, the big problem facing Darling was that hopes were perversely high.  This was one of the most anticipated Budgets in decades, with commentators on both the left and right urging dramatic action.  Be bold Chancellor, you could be our next Lloyd George,” said Polly Toynbee in The Guardian.  “Give voters a rock-solid reminder of what Labour is for”.  The Times was equally convinced that that Chancellor should follow the advice of President Obama’s chief to staff, Rahm Emanuel, and not let “a serious crisis to go to waste”.

With the weight of the public finances endangering the nation’s prospects for recovery, the Budget presented a perfect opportunity for ministers to change course away from ever-rising public expenditure and to profoundly change the shape of the government.  In the event, the Chancellor did announce a cut in public service spending growth:  it will fall from 1.1%, to 0.7% in 2001-12.  He also announced £15bn in “efficiency savings”.  But this is a little more than tinkering around the edges, £15bn over five years represents only a fraction of Britain’s annual interest payments on its public debt.  Far more profound changes are needed in a public sector that has grown out of all proportions to Britain’s ability to pay.

Darling’s Budget task was daunting enough to evoke pity. He had to reassure investors that Britain isn’t going bust, but to do so without taking too much money from the beleaguered taxpayer, or out of and economy in deep recession.  His response was a flight into fantasy. There was no bust Britain, he seemed to say, only a temporarily tripped-up Britain, which would soon be swanning along again.  He offered no meaningful explanation of how the deficit would be shrunk.  He acted like a fantasist – presenting the terrible news and pretending it didn’t matter.  Britain’s black hole required an adult response.  We didn’t get it.