THE BEAR'S LAIR A tale of two downturns
By Martin Hutchinson
British observers have in the past year indulged in a considerable amount of schadenfreude
about the US subprime crisis, the excessively expansionary monetary policy of
US Federal Reserve chairman Ben Bernanke and the substantial recession that
appears impending. They should be less eager to gloat; the recession into which
Britain is heading is likely to be considerably more serious than its US
counterpart, and the way out less certain.
One reason for Britain suffering a deeper recession than the US is that its
house prices got more out of line. Whereas in the United States, the house
price to income ratio peaked at 4.5 times, against a long-term average of about
3.2, in Britain in 2006 that
ratio peaked at around 5.5 times. Housing is more tax-advantaged in the United
States, since mortgage interest payments are tax deductible, unlike in Britain.
Hence the equilibrium British house price to income ratio would appear to be
about three times, marginally above the 2.7 times level of 1970, when the
British housing market was close to equilibrium. That implies that an average
fall in real British house pieces of 45% is needed to bring the market back
into equilibrium, considerably larger than the 29% drop needed to bring the US
market into equilibrium.
Those figures may seem startlingly high but remember: the average Tokyo house
price dropped by no less than 70% between 1990 and 2005, as Japan's 1980s stock
and real estate bubble deflated. Thus a 45% drop is perfectly within the bounds
of possibility. The US housing market appears well on its way to the necessary
29% correction, with the Case-Shiller house price index already down 18% since
late 2006. Conversely, the British market has only just begun to drop in price,
with current national average prices down by no more than 5%. Hence the future
economic effect of the housing downturn is likely to be considerably more
pronounced in Britain than in the US.
There are however other reasons for believing that Britain is likely to have a
deeper recession than the US, the principal of which is the different structure
of the British economy. Not only is it more finance-oriented than that of the
United States, but its finance sector appears considerably more vulnerable,
largely because of the lack of locally controlled institutions involved in it.
One of Shakespeare's better-remembered lines, from Julius Caesar is:
The
evil that men do lives after them,
The good is oft interred with their bones.
For almost no
political leader has this been so true as for former premier Margaret Thatcher,
thankfully still with us but surely watching in horror as the positive parts of
her legacy disintegrate while her few mistakes return to haunt us in ever more
terrible form.
She cut back the size of the bloated British public sector, but today it is
larger in terms of gross domestic product than when she came to power. She
brought a new assertiveness to Britain's relations with the European Union, and
today the EU is forcing through a treaty that would be rejected by an
overwhelming majority of the British people.
With president Ronald Reagan, Thatcher brought about the fall of communism, but
today Vladimir Putin's Russia is as threatening to the West as any Soviet
regime since Josef Stalin died, and we can't even rely on the inherent
contradictions in its economic management to weaken it.
Thatcher brought a new self-discipline and self-respect to the British people,
but today the British people are as wayward and feckless as they have ever
been. She more or less invented privatization, but today that technique of
extracting assets from the dead hand of government is little used, and the net
British and global trend appears to be towards more state control, not less.
She defeated the trade unions, an achievement that still stands, but maybe they
would have been defeated anyway by the forces of globalization and the
disintegration of the British manufacturing sector.
As for her mistakes, we have been given a stark reminder this week of her first
major political blunder, the 1979-80 Lancaster House settlement of
Rhodesia/Zimbabwe. When she came to power, an internal settlement for that
country had been achieved and a majority-population prime minister, the
moderate and respected Bishop Abel Muzorewa, had come to power through
elections agreed by international observers to be free and fair. All she had to
do was ratify the process that had produced Muzorewa, regularize
Rhodesia-Zimbabwe's independence, and provide a certain amount of aid and
investment, and Zimbabwe would have become a beacon of relative prosperity in
the continent and a staunch British ally.
Instead, Thatcher succumbed to the politically correct machinations of her
feeble foreign secretary, Peter, Lord Carrington, and the incorrigibly leftist
Foreign Office, and forced a settlement that deprived the elected incumbent
government of office and allowed the Marxist terrorist Robert Mugabe to
intimidate his way to power. Mugabe has been there ever since, representing no
sort of democracy and driving his terrorized populace into ever greater misery
and penury. Seldom if ever has political feebleness brought such catastrophic
results, none of which have accrued to the prime minister responsible or the
electorate that chose her expecting better.
Thatcher's reorganization of the City of London by the Financial Services Act
of 1986 is likely to produce fewer actual fatalities but in the long run may be
even more damaging, at least economically. It was designed on a wholly
fallacious theory that London's financial "playing field" should be leveled to
produce a more competitive marketplace. It abolished market structures that had
worked well for close on 300 years, replacing them with an inferior copy of the
structures prevalent in New York. It was implemented shortly after a decade in
which the British merchant banks had been devastated by recession and
near-hyperinflation, so that in real terms they were a quarter the relative
size they had been in 1970.
The result of removing the market mechanisms with which local houses had been
familiar and subjecting them to fierce competition from much larger foreign
banks (who themselves remained protected in their domestic markets) was
inevitable; within 15 years of the act's passage the London merchant banks were
not merely foreign-owned but non-existent. It was the most suicidal British
economic legislation since the 1846 Repeal of the Corn Laws.
The long-term damage to Britain's economy caused by the 1986 Act has been a
generation in arriving, but appears now to be on us. At the 20th anniversary of
the act's implementation in November 2006, there was much bien-pensant rejoicing,
with declarations that the City and Britain in general were incomparably more
cosmopolitan and better off as a result of it.
As we now know, that rejoicing was premature, since the anniversary coincided
almost precisely with the apogee of the financial services bubble that has
since so damagingly begun to implode. The fancy bonuses achieved by the
remaining British bankers, kowtowing vigorously to their masters in Frankfurt,
Paris, Zurich or New York, are unlikely to be matched again for at least a
couple of decades, if ever.
It seems most likely that the financial services industry, which approximately
doubled its share of world value added between 1980 and 2006, will shrink back
to somewhere close to its original size. Many of its "innovations", such as
securitization, turn out to have had fatal flaws in their incentives design
that produced aberrant and in some cases criminal behavior by participants.
Global overcapacity in the sector is likely to reduce both individual
remuneration and the fees charged by financial institutions.
The multi-tiered investment management business, in which many funds were
distinguished solely by the splendor of their fee structures, is likely to
shrink back to a modest economic activity that competes mostly on price. A
return to much tighter monetary policy and real interest rates well above zero
will greatly reduce the amount of loose money sloshing around the world looking
for a home.
Britain is likely to be more deeply affected than the US by a prolonged
implosion in the financial services business for three reasons. First, and most
simply, it is a more important part of the British economy, and its decline
will cause more difficulties in the London real estate market, up-market
retailing and so forth than will the equivalent decline in New York. Second,
Britain has more or less hollowed out its manufacturing industry. We are
already seeing some of the effect of US resilience this year; as the financial
services business gets into greater difficulty and the dollar declines,
manufacturing companies such as John Deere are able to take advantage of the
weaker dollar and high commodity prices to expand their businesses at a rapid
rate. Britain has few such opportunities.
Finally, Britain will suffer an additional recessionary effect from the
"branch-plant" nature of its remaining financial services business. Asian
finance is already moving increasingly to Asia, since London is in reality
little more convenient than New York to carry it out. US finance, to the extent
it has migrated to London, will migrate back to New York, since skilled staff
will be available there in profusion as the business shrinks.
Only the slow-growing European Union and maybe some Middle East business will
remain in London. However, other European financial centers and Dubai are keen
competitors in those areas; to the extent the Middle East remains a viable
economic region once oil prices decline, it will probably want to carry out its
own financing, and the same will be true of the other major European countries.
With few significant domestic institutions, London's global market share is
thus headed sharply downwards, reducing employment opportunities and revenues
even beyond the effect of the shrinkage in the financial business generally.
Not only is it easy to see how the British economy could sink into a recession
much deeper than in the US, it is difficult to see how it can emerge from that
recession to renewed prosperity. Certainly a revival of London's historic
position as a financial services entrepot seems highly unlikely.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-07 David W Tice & Associates.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
