Thursday , December 2 2021
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Let our woes begin…

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Today is open up day for the beleaguered folk of the UK.  Non-essential shops, pub and restaurant gardens and children’s indoor activities are all open for the first time since Christmas.  And the media narrative that accompanies this new stage of the pandemic response is that the economy is poised like a coiled spring.  Having massively increased savings since SARS-CoV-2 arrived last February, the expectation is that we are all going to be queuing at high street stores to buy all of the consumer goods we have missed out on.  Far from a prolonged recession, we are – we are told – at the start of a new, consumer-led age of prosperity.

One reason for why journalists and political cheerleaders are playing up the prospects of a return to growth is the belief that “external” shocks to an economy tend only to be short-term.  For example, David Thorpe at FT Advisor suggests there are three types of recession; cyclical, structural and event-driven.  Cyclical downturns – such as the mild recession following the end of the DotCom bubble – tend to have little impact on the majority of people. Structural downturns – such as the 2008 crash and ensuing depression – have a much greater impact because they are a consequence of flaws in the system itself, and thus impact across the economy.  Event-driven downturns are more severe, but also short-term:

“The pandemic is an example of an event-driven recession, as it impacted all economies negatively, regardless of the condition of those economies when the event happened… while event-driven recessions tend to be far more severe, they are also typically shorter, and with a much deeper bounce back, as when the event goes away, the economy can return to something like its pre-recession condition.”

Importantly, savings remain high despite more than a year of lockdowns and restrictions.  According to the Office for National Statistics, UK savings have grown by more than £200bn since the beginning of 2020:

“In more typical recessions, savings rates are very low when the recession strikes, as they usually follow a period where credit was easy to obtain and confidence among the public was high.

“When the recession subsequently comes, people are forced to deplete their savings to make up for the loss of income.

“This then slows the recovery from the recession when the cycle turns or the structural issues have been addressed, as people use their enhanced income to pay down debt, or build up savings.”

This is essentially the same “V-Shaped” recovery that failed to put in an appearance around this time last year.  Certainly, when the lockdown ended there was a rush to the shops, as people sought everything from haircuts to new summer clothing.  But the spending spree petered out within a fortnight; largely due to uncertainties about the pandemic and the prospects for the economy.

Adding to the failure to spend, is the grossly uneven distribution of the additional savings.  Those on the bottom three-quarters of Britain’s income ladder are more likely to have eaten into their savings in the course of the last year.  Not least because they make up a large part of the “essential workers” who have carried on while the rest of us remained locked up in our homes.  Continuing to have to pay all of the costs of having a job – transport, clothing, prepared food and drink, etc., – and unable to afford time off to self-isolate, these workers have borne the brunt of the pandemic restrictions.  But even those who have been able to work from home have incurred additional costs.  Where previously, employers were picking up the cost of utilities and even… dare we mention it… toilet paper, home workers have found themselves picking up the extra costs.

Many in the lower half of the income distribution began the pandemic with nothing in the way of savings; and many were already loaded up with credit card debt and overdrafts.  And these have tended to grow in the course of the past year.  According to The Money Charity the average UK personal debt has risen by £2,300 since March 2020:

“According to the office for budget responsibility’s march 2021 forecast, household debt of all types is forecast to rise from £2,006 billion in 2020 to £2,354 billion in 2025…

“Citizens advice bureaux in England and Wales dealt with 1,616 debt issues every day in the year to February 2021…

“275 people a day were declared insolvent or bankrupt in England or Wales in December 2020 to February 2021. This was equivalent to one person every 5 minutes and 12 seconds.”

What this means is that the people most likely to go out and spend have even less money in April 2021 than they had in March 2020.  Meanwhile almost all of the winners are located at the very top of the income ladder where there is less need to spend, and where lower numbers prevent a widespread consumer boom.  This is the point made long ago by Amazon founder Nick Hanauer – rich people still only buy one car, one watch and one suit.  What they can’t do is to make up for the lack of spending by the majority.

Even if there is some desire to go out and spend, as happened last year, this will be tempered by concerns about the long-term prospects for the economy.  Even with the rollout of vaccines, the pandemic is far from over.  And we are all aware that governments can shut things down far quicker than they are currently unlocking.  So, better to set money aside for a rainy day, rather than rush out and blow it on new clothes that you may never get to wear.

Nor are things looking positive on the broader economic front.  Because, far from David Thorpe’s rose-tinted view of the future, what we are unlocking into looks more like a combined cyclical, structural and event-driven downturn all rolled into one mega clusterfuck.  Not that most of us noticed, but the period after the 2008 crash had been one of the longest periods of economic growth in history.  For this reason alone, prior to the pandemic, many commentators had been anticipating a cyclical downturn of the kind that just happens once a decade or so.  However, we have been in a structural crisis throughout those years as a consequence of our not resetting the system in 2008.

As John Harris at the Guardian notes, the retail apocalypse didn’t begin with Covid-19:

“In March 2010, there were reckoned to be 286,680 retail outlets in the UK. A decade later, even though online consumerism had grown to about 20% of total spending, the figure was 306,895. We have become, it seems, a country with simply too many shops. Retail analysts say that in some places the amount of space given over to retail needs to come down by about 30%, which would obviously be a drastic and hugely disruptive change, to the built environment and people’s everyday lives.

“In truth, a shift of this magnitude is probably already happening. And capitalism being capitalism, it is largely being left to let rip…

“In retrospect, all this highlights a Great British mistake, whose consequences have been rippling through our politics for a very long time. From the 1980s onwards, retail was promoted as a means of filling the gaps left by shut-down industries… And now? Deindustrialisation is being succeeded by deretailing, with potentially big consequences. If you want a vision of one possible future, consider that in the US Amazon is buying up shopping malls and turning them into distribution centres. That might look like a means of creating new jobs, but there’s an obvious tension: such workplaces are also at the cutting edge of the replacement of human beings by robots.”

Walk down any UK high street and you may take some comfort from the signs which read, “Temporarily closed due to the pandemic.”  But we are all too aware that closures and layoffs will be coming soon.  As Harris explains:

“Precise numbers for the entire retail sector are hard to come by, but over the course of 2020, Great Britain is reckoned to have lost about 17,500 chain outlets. In the six weeks until mid-February this year, more than 1,000 more announced their closure; the rate of job losses is now put at 850 for each working day. Once businesses exit the current pause on business rates and the furlough scheme draws to its planned close in September, there will presumably have been even more casualties: some forecasters predict that there could soon be as many as 80,000 vacant shops around the country.”

Similar patterns have emerged in hospitality and tourism too.  And small businesses across the board are also facing hardship once the various support schemes come to an end… and we may not have to wait until September for the carnage to begin.  As Helen Cahill and Emma Dunkley at This is Money report:

“Banks are allocating hundreds of extra staff to spearhead the recovery efforts and bosses have been in regular talks with the Treasury to finalise plans.

“HSBC, NatWest, Barclays and Lloyds have all begun dispatching letters to customers to warn them that repayments will soon be expected.

“Banks have handed out more than £75billion to 1.6million firms under a number of emergency support schemes set up by Chancellor Rishi Sunak and backed by the taxpayer. Businesses were granted an interest-free period of a year and are due to start making repayments in as little as two weeks’ time.”

Nor is debt-recovery the only cannibalistic sector of the economy to be creating employment just as the wider economy begins its journey around the U-bend.  As an editorial for the Institute of Chartered Accountants in England and Wales explains:

“Government support measures have been a lifeline for millions of UK businesses. As of February 2021, £53.8bn have been claimed under the Coronavirus Job Retention Scheme (CJRS), furloughing 11.2m people. Over 1.5m businesses have received loans worth over £74bn, including future fund loans, business interruption schemes and bounce back loans.

“But, says Greg Palfrey, Partner and National Head of Restructuring & Recovery Services at Smith & Williamson, while being hugely supportive, these measures have also kept large numbers of struggling businesses artificially afloat, therefore prolonging the inevitable. It’s why we haven’t seen spikes in firms going into insolvency – at least not yet…

“There are typically two insolvency spikes: one during the first stage of a recession where badly-run companies fail and one at the end where work levels pick up but companies lack the working capital to fund increased demand… Either way, the UK is in for a very bumpy period, particularly for businesses hanging on by a thread. At some point, Palfrey warns, councils will need to restart collecting rent, banks will collect loans, HMRC will collect debt, and the British Business Bank will recover funds.”

Such are the likely shocks awaiting the UK domestic economy.  However, these will pale into insignificance compared to growing supply-side problems across the global economy.  Most of the businesses opening up on British high streets today are selling off stock that has been in storage since last year.  But shortages have developed across the economy in everything from cardboard containers and garden furniture to microchips and, yes, toilet paper (or at least the wood pulp from which it is made).  Moreover, the disruption to shipping over the last year has resulted in a four-fold increase in shipping costs from Asia to the UK.  In the case of orders placed before the pandemic, retailers have had to eat the additional costs; even though this makes some items loss-making.  But as the economy opens up and more orders have to be placed, those costs – or at least a large part of them – will have to be passed on to consumers.

Shipping costs are not the only problem facing businesses as they unlock.  Conventional oil extraction fell by 20 percent in the last year.  And since most of those oil fields were already depleting, that production may well not return.  And while some of the shortfall will be made up from deep water and unconventional sources, this will take time.  As a result, we may well face an oil price shock later this year as demand attempts to balance supply.

This could spell disaster for the large number of “zombie” firms and households which never truly recovered from the 2008 crash.  As Vikram Khanna at the Straits Times writes:

“When it comes to companies, many studies show that as economies start to recover from crises, solvency problems often become more, not less, serious, and this is also likely during the post-Covid-19 recovery.

“One recent study by International Monetary Fund (IMF) economists is based on an analysis of 2,600 non-financial firms from six major Asian economies: Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam…

“Even before the pandemic, about one-third of the firms could not cover their interest payments and a quarter were already ‘zombie’ firms that had debt service problems for at least five years. This was especially true for firms in energy (especially prominent in Singapore’s case), materials and consumer discretionary industries such as white goods.

“Then came the pandemic. The IMF study points out that had there been no government support, there would have been a wave of corporate bankruptcies: Almost half of the firms would have been unable to cover their interest payments last year and one-third would have run out of cash by the year end…

“But in many countries, bankruptcies were unusually low last year. Despite the worst recession ever, bankruptcy applications in Singapore, which had been rising since 2014, fell more than 18 per cent compared with the pre-Covid year of 2019. This was because of government support in the form of the Jobs Support Scheme (JSS) and other forms of assistance, as well as reliefs from contractual obligations and bank forbearance.

“For instance, the minimum threshold for debtors to be exposed to the threat of bankruptcy was quadrupled from $15,000 to $60,000, and they were allowed six months to pay up rather than the 21 days pre-Covid-19. The circuit breaker from April to June might also have prevented bankruptcy proceedings from taking place.”

State and central bank support, then, is a global phenomenon rather than something unique to the UK.  And this spells even greater hardship ahead in the event that governments around the planet attempt to simultaneously withdraw the support schemes.  But what choice do they have?  The idea that we can continue as we are now is fanciful.  Yes, there is still scope within economies for governments to borrow new currency into existence for the domestic economy.  But few economies are sufficiently self-contained for this not to cause problems.

Britain’s wished for consumer boom, for example, may provide temporary benefits for store owners and retail employees.  But most of the goods being sold will have been imported, because Britain sold off its manufacturing base decades ago.  And this means that all of that new currency will have to be exchanged on international markets; and the more of it we print, the less attractive foreign manufacturers will find it.  And so, to add to the coming increases in prices resulting from shipping and resource supply problems, we can add the likely devaluation of the currency on international markets.

What this adds up to is some unpleasant price increases across a range of goods and services later in the year: Which is when the potential for mayhem really gets going.  It was increasing prices across the economy in 2006, resulting from an oil price spike, which persuaded the world’s central bankers to begin to jack up interest rates in the wrong-headed belief that they were facing runaway inflation.  Rising interest rates led to mortgage defaults and company bankruptcies – which led to even more mortgage defaults – which, in turn, unravelled the whole banking and financial system.

One reason for the error was that mainstream economics textbooks do not distinguish between inflation and price rises.  However, while price rises can be a symptom of inflation, the true sickness if excessive currency expansion.  Prices though, may increase for other reasons; including precisely the kind of supply-side shocks brewing across the global economy today.  Treat these as if they were the result of the various state support schemes and we risk turning a downturn into a catastrophe.  This is because the main tool with which politicians and central bankers will turn to in an attempt to force prices down again will be higher interest rates.  And if interest rates are jacked up, the result will be 2008 on steroids; because none of the structural flaws revealed in that crisis were ever resolved.  Last time around, governments stepped in to save banks.  This time around it will be governments themselves that need bailouts.  And in the absence of space aliens, it is far from clear who is going to ride to the rescue.

In the end, doing what we should have done in 2006 may be the better option.  After all, the supply-side shocks are primarily the consequence of the remorseless rise in the energy cost of energy.  Having used up all of the cheap and easy resources, we now find ourselves sucking up the dregs.  And the true cost of that in the real economy is that everything has to cost more.  That is not “inflation,” that is an economy trying to rebalance itself to where it would have been if governments had allowed the banks to fail rather than throw QE at them.

In most cases, the coming price increases are going to hit non-essential goods and services – the kind most of us have done without while being locked in our homes.  Essentials like food have yet to be impacted.  But when food prices do increase, people will simply rebalance their spending; doing without non-essentials in order to pay for essentials.  But since interest payments are also an essential spend, raising them only serves to exacerbate the problem at this stage.  Any business selling non-essential goods and services is going to have no choice other than to pass the cost onto consumers.  And if consumers can no longer afford to pay, those businesses are going to go bust.  But eventually a different economy will emerge with an altogether different mix of goods and services and, most likely, a far less materialistic culture.

The greatest mistake of all as we emerge from our enforced 18 months of “event-driven” economic mayhem would be to attempt to set the clock back to January 2020 or to recreate the boom of the late 1990s.  That iteration of the global industrial economy is over.  It will be those states which are able to adapt to the new, materially constrained circumstances which will fare best in the long-term.  I fear that the UK will not be one of them.

As you made it to the end…

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